What is DeFi
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DeFi or Decentralized Finance is an emerging market segment in the financial services industry. It’s a new way to think about the application of finance and capital markets that decentralizes it all. In this ecosystem, participants are able to directly transact with one another while bypassing intermediaries such as banks, brokers, and other traditional intermediaries. This post will give you a quick overview of DeFi and its implications on the future of fintech. If you’re ready to dive deeper into these concepts, we have outlined a few pointers for where to do so at the end of this article.
What is DeFi?
DeFi stands for Decentralized Financial Services. It refers to the blockchain and crypto-enabled ecosystems that enable parties to directly transact with one another. In this ecosystem, participants are able to directly transact with one another while bypassing intermediaries such as banks, brokers, and other traditional intermediaries. A key difference between the centralized and decentralized models of finance is that the decentralized model is, by nature, open and transparent where the centralized model is usually closed and opaque.
Benefits of DeFi
A few key advantages of DeFi include: - Opening up financial services to all: Traditional models of financial services have had barriers to entry for certain groups such as people with low income, those with low credit scores, and the unbanked. The DeFi model is highly inclusive and anyone who has access to the internet can use it. No one is left behind. - Mobile-first: The DeFi model is built around a mobile-first model. This is in contrast to the centralized model where the primary entry point is usually a desktop/laptop computer. DeFi is accessible via a mobile device so it’s much more convenient and accessible. - Cutting out intermediaries: DeFi platforms work without intermediaries and allow users to directly transact with each other. This cuts out the middlemen who add no real value to the transaction. - Open and transparent: In the centralized model, intermediaries usually keep the transaction details hidden from the public. This opens a pandora’s box of potential issues and problems. In the DeFi model, everything is open and transparent.
Crypto-backed loans (e.g. Dharma, dApp loan platforms)
Crypto-backed loans are a type of loan where the loan amount is backed by crypto assets like Bitcoin and Ethereum. The crypto assets are used as collateral for the loan amount. This means that if the borrower fails to repay the loan, the lender can liquidate the crypto assets to repay the loan amount. Crypto-backed loans are ideal for people who want to use their crypto assets to secure a loan amount. However, lenders are often wary of the risk that the loan amount might not be repaid. While this is a well-founded concern, there are ways to mitigate this risk. - Reputation system: A reputation system that is similar to a credit score is a proven way to mitigate the risk of non-repayment. If a borrower fails to repay their loan, they lose reputation points in the system. - Crypto insurance: Another way is to use insurance policies that offer protection against the risk of a borrower failing to repay their loan. These policies are backed by collateral and are a great way to mitigate the risk of non-repayment.
Crypto-backed securities (e.g. Compound, Procter & Gamble Co.)
Crypto-backed securities are a type of financial instrument where an underlying asset is backed by crypto assets. In this case, the assets can be equity shares/stocks, bonds, commodities, and other assets. Crypto-backed securities are a great way for investors to diversify their portfolios. It also lets investors participate in the crypto market without having to actually own any crypto assets.
Blockchain-based lending platforms (e.g. ETHLEND)
EthLend is a blockchain-based lending platform that lets you use your crypto assets as collateral for fiat loans. The borrowers use their crypto assets as collateral against the loan amount and are given the fiat loan amount in return. The lenders get a fixed interest rate on the loan amount. If the borrower fails to repay the loan, the lender gets to keep the crypto assets as collateral. This is a great way for crypto investors to make extra money by lending their crypto assets.
Peer to Peer lending platforms (e.g Lending Club and Prosper)
Lending Club and Prosper also conduct their lending activities as peer-to-peer lending platforms. This means that lenders and borrowers conduct their transactions with one another directly. No intermediaries such as banks or financial institutions are involved in the transaction. This is one of the most basic forms of Defi. In this model, lenders and borrowers transact with each other and there are no third-party intermediaries involved in the transaction.
Conclusion
There are a lot of different types of decentralized financial services or Defi. And each of these types has a very different set of functions. Defi has the potential to disrupt the financial services industry by cutting out the middlemen who add no real value to the transaction. This is something that the traditional financial services industry will have to keep an eye on.