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Decentralized finance is a new-age financial system based on blockchain technology. It relies on market forces for valuation, unlike the traditional financial system, which has central intermediaries. This overview of decentralized finance sheds light on its history, basic technical operations, and its difference from the formal financial system. It also touches on the relationship between DeFi and crypto, and the projects surrounding the concept.
The liberalization of economies and cross-border trade makes the price of money elastic. The price of commodities fluctuated based on the price of the US Dollar. It increased the cost of business, especially for business people who have to change their currency into USD or the Euro. In essence, the respective central banks are the go-between the producer and consumer. They dictate the price of money based on controlled monetary policies.
Financial engineers came up with an alternative system that had independent valuation parameters. It does not have a central control system that dictates its worth, neither does it have a physical trading outlet. The more the demand, the more the value, eliminating the intermediary. This is the concept behind decentralized finance, and Ethereum is a good example.
The system uses blockchain, one of the most secure online cryptographies, to manage the transactions. Each transaction happens in crypto-based blocks that require several authorizations, making it safe. Decentralized finance allows lending, price speculation, trade with other cryptocurrencies, and earns interest for savers.
Blockchain
It houses all transaction details and statements of accounts.
Processes
It has protocols that guide transaction functionalities without human interference.
Currencies
The store of value or tokens; cryptocurrency (Ether, Bitcoin, etc.)
Platform
The applications with instructions that are used to manage crypto activities
Bitcoin is the first decentralized financial project dating back to 2009. Its concept paper is the yardstick that other DeFi Projects base on. The peer-to-peer transaction network and its blockchain-based ledgers open up the system to anyone but still maintain user anonymity. Simply put, DeFi general overview and structure borrow heavily from Bitcoin.
However, MakerDAO is the first modern-age decentralized financial platform to receive significant traction. Stablecoins were its resident cryptocurrencies, which allowed lending to its users. Ethereum worked on the concept using Ether as their cryptocurrency, and as it stands now, it is the most recognized DeFi platform in digital finance. Most DeFi projects grew to offer loans, manage repayments, and liquidation processes.
Whereas both financial systems serve the same purpose, every system has its technical and operational approach. Some of the notable ones include:-
DeFi general overview shows a system driven by users. They determine its value, volume and can directly manage their wallets. On the other hand, the classic finance system operates in a closed system governed by institutional policies.
DeFi explained simply is a perfect alternative to a commercial bank without regulations or actual tellers. It offers all the services one can get in a physical bank, although no one controls its activities.
Although the explanation of DeFi is glittered with modernity and financial independence, there are few issues with the system.
Uncertainty – be it system or market uncertainty, any element destabilizing the system or the crypto endangers its reliability.
Liquidity – although its market capitalization is growing, DeFi general overview makes it inferior to the centralized financial systems. It might take time to be a significant threat in world finance.
The hands-off approach is sometimes detrimental to DeFi’s growth. The system doesn’t solve all teething problems. Any slight mishap can cause significant damage to the system, which can affect its reliability.
DeFi explained simply is a global, unregulated financial system that gives its users the power to determine its valuation. Its origin is Bitcoin’s concept paper, although MakerDAO is the first decentralized finance system. As the crypto economy continues to grow exponentially, it brings bigger DeFi projects onboard.
The main difference between the classic and DeFi examples is regulations. Whereas classic finance requires institutionalized policies, it works with demand and supply.
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