Decentralized finance (or DeFi) has received unprecedented attention over the last two years, so it’s not out of the question to show it a little closer. In the future, they are likely to have an even more significant impact on the financial system and banks‘ functioning than they do now.
DeFi application and financial system
Decentralized finance is a general term for a financial system that operates without any third party, such as banks, insurance companies, or other financial institutions. DeFi is thus performed based on smart contracts.
In the summer of 2020, the decentralized experienced a big boom that catapulted the price of some DeFi tokens to rocket heights. Billions of US dollars have been invested in the ecosystem, with growth mainly driven by Etherea-based applications. Why has DeFi become so popular?
Cryptocurrency loans through decentralized finance
For the first time, DeFi protocols allow you to borrow a more considerable amount of money between unknown participants and without any third parties. DeFi applications connect creditors and debtors, who set interest rates themselves by supply and demand.
Projects like Compound or Aave heavily drive cryptocurrency loans in the DeFi industry. Loans are truly inclusive because they are secure and can be communicated with by anyone from anywhere in the world.
Other functions of decentralized finance include insurance. For example, DeFi company Nexus Mutual offers insurance covering errors in smart contracts. Decentralized insurance is still at an early stage of development and cannot be relied on at present.
The basis for decentralized finance was laid by stablecoins, which act as a reserve currency. Blockchain-based stablecoins allow participants to engage with each other without the risk of price fluctuations. Decentralized finance is also part of several stock exchanges
With the development of DeFi, the popularity of cryptocurrency decentralized exchanges has also increased, where cryptocurrency holders no longer have to leave the crypto space to exchange their tokens. An example is the decentralized Uniswap exchange.
Decentralized finance is still at an early stage of development, but several reasons may one day replace the traditional financial system.