The use of decentralized finance - a combination of blockchain and smart contracts - is actively gaining momentum around the world. It is DeFi that is dedicated to today's article on our Buyex blog.

What is decentralized finance?
DeFi is a type of ecosystem of blockchain-based financial applications. The goal is to create an open, free and transparent system of financial services, accessible to any user and working without government intervention. The idea is that DeFi will replace the traditional technologies of the current financial system with open source protocols that meet the same needs. User interaction occurs through peer-to-peer P2P, decentralized dapps applications.
The DeFi financial instrument is based on open source protocols and modular structures. Many DeFi applications offer hybrid options for digital assets / traditional financial services. The analog name for such hybrids is open funding.

Key benefits of DeFi

The main advantage of decentralized finance is easy access to financial services, a modular framework and interoperability of applications based on public blockchains. In addition to the above, there are also other advantages:

  • the creation of a completely new type of financial markets, products and services;
  • lack of need for mediators and the judiciary;
  • lack of censorship and shutdowns;
  • ease of access to financial services for absolutely everyone;
  • reduction in the cost of operating money markets;
  • lower emissions and costs for the end user;
  • DeFi implementation on different platforms.

Use cases

Loan and credit

Perhaps the most popular way to use it is through open credit protocols using DeFi. Advantages: instant transaction calculation, the ability to secure digital assets, the absence of credit checks and potential standardization in the future.
This type of service is built on blockchain technology, which removes the need for trust and provides a guarantee of the operation of cryptographic verification methods. Credit market placements on the blockchain reduce counterparty risk (counterparty risk), make loans and loans cheaper, faster and more affordable for more people.

Monetary banking services

DeFi allows the availability of monetary banking services, which makes it possible to issue stablecoins, mortgages and insurance. The advantages are the complete absence of intermediaries in mortgages and insurance. Using smart contracts, underwriting and legal fees can be significantly cheaper.

Decentralized markets

Some of the most important DeFi applications are decentralized exchanges (DEX) and open marketplaces. These platforms allow users to trade digital assets without a trusted intermediary (exchange) to store your funds. Transactions are made directly between user wallets using smart contracts. Blockchain technology can also be used to issue and authorize ownership of a wide range of traditional financial instruments. Such applications will work decentralized, this eliminates the need for a single point of failure and custodians.

The role of smart contracts in DeFi
The creation and use of smart contracts is an almost mandatory stage in the existence of decentralized finance. Instead of the usual legal contract of the parties, DeFi uses a computer code, which is called a smart contract.
Smart contracts have a unique application feature, which provides automation of a large number of business processes that currently need manual configuration. Smart contracts open up the possibility of reducing the possible likelihood of adverse events for both parties. However, even computer code is susceptible to vulnerabilities and errors in it, which opens up new types of risk.

DeFi Problems

  • Slow performance: DeFi developers must take into account the slow operation of blockchains and optimize their applications to increase productivity.
  • High risk of user error: developing products that minimize the risk of user error is a particularly difficult task when products are deployed over immutable blockchain networks.
  • Bad user experience: DeFi applications require the user to be especially involved in the process, for which new technologies need to appear to users so profitable and convenient that they refuse to use traditional methods.
  • The mess of the ecosystem: the interaction of applications among themselves is a rather difficultly realized moment. It will also be difficult for an inexperienced user to choose the right one from the variety of DeFi applications.

What is the difference between DeFi and Open Banking?
Open banking is a banking system in which third-party financial service providers are provided with secure access to financial data through the API. Open banking allows you to combine accounts and data between banks and non-banking financial institutions, as well as provide access to new types of products and services within the traditional financial system.

DeFi (open finance) is a completely new financial system, independent of existing infrastructure. Decentralized finance can provide management of completely new types of financial instruments and new ways of interacting with them.

The concept of decentralized financial services focusing on building financial services that are separate from traditional financial and political systems will create a more transparent financial system without censorship and discrimination around the world. Despite the beauty of this idea, at the moment it is not known exactly how much this decentralized financial system will be effective and even more so when decentralized finances will become commonplace and will be accepted by the public.