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Finance and Accounting
Decentralised finance (DeFi) has become very strong in the last few years. We can attribute its exponential growth in such a short period to more transparency and accessibility to investors than traditional financial systems.
The technology, though, is still nascent and has not been extensively tested for scale and sustainability. Unlike conventional banking systems, DeFi operates on the principles of decentralising financial services and empowering individuals to access, invest, and transact with unprecedented freedom.
This blog explores its core principles, key components, and the transformative impact it holds for the future of finance.
Understanding the essence of DeFi
DeFi represents a financial system built on decentralised, permissionless blockchain networks. Unlike traditional finance, which relies on intermediaries to facilitate transactions and manage assets, DeFi operates through decentralised applications (dApps) on blockchain networks. The dApps enable direct access to financial services, where cryptocurrencies and digital assets are collateral or payment mechanisms.
DeFi operations and blockchain
DeFi operates on code developed on the decentralised framework of Ethereum blockchain technology. Ethereum utilises smart contracts for secure validation and execution of application code, facilitating direct access to financial services through decentralised applications (dApps). The process unfolds as follows:
Digital wallet creation
Users establish digital wallets, typically on the Ethereum network, to safeguard their cryptocurrencies and digital assets.
Asset deposits
Users deposit various assets, including cryptocurrencies, into their digital wallets.
Smart contract locking
Smart contract lock assets, self-executing agreements on the blockchain that dictate the terms of financial services.
Access to financial services
Users access various financial services via dApps on the DeFi network, such as lending, borrowing, trading, and insurance.
Smart contract execution
Smart contracts autonomously execute financial services, strictly enforcing their terms. For instance, collateral is held in lending until loan repayment, automatically releasing funds upon repayment.
Fees and rewards
Users may incur lower access fees due to the absence of intermediaries and earn rewards for contributing to the DeFi network, like lending on a decentralised exchange.
Asset withdrawal
When users withdraw funds from their digital wallets, smart contracts promptly release the assets.
As the DeFi ecosystem matures, expect to witness further groundbreaking financial services and applications.
Applications of DeFi
DeFi offers a multitude of use cases and applications like:
- Lending and borrowing
- Trading
- Insurance
- Asset management
- Payments
- Decentralised identification
- Investment
- Innovation
- Regulation
DeFi’s applications span various financial services, promising accessibility, transparency, and efficiency.
DeFi’s impact on the traditional banking system
DeFi is disrupting traditional finance in numerous ways:
- Eliminating intermediaries: DeFi reduces transaction costs and increases efficiency by removing intermediaries like banks.
- Increased accessibility: DeFi makes financial services more accessible, especially to the unbanked and underbanked.
- Transparency: DeFi fosters transparency in financial transactions, mitigating fraud risk.
- Programmable finance: DeFi’s programmability allows bespoke financial solutions and applications, fostering innovation.
- Global reach: DeFi is accessible worldwide, enabling anyone to offer financial services.
Benefits and challenges of DeFi
DeFi presents numerous advantages over traditional financial systems:
- Accessibility
- Cost reduction
- Programmability
- Decentralisation
- Transparency
- Interoperability
- Security
- Innovation
However, DeFi has its drawbacks. Some of the major concerns include:
- Complexity
- Volatility
- Security risks
- Liquidity risks
- Regulatory uncertainty
- Lack of user protection
Users and investors must carefully consider the benefits and risks of DeFi.
What does the future hold for DeFi?
DeFi holds a promising future with the potential to revolutionise the financial sector. Anticipated developments include:
Continued expansion
The DeFi market is expected to grow, with broader acceptance and integration with traditional finance systems.
Interoperability
DeFi platforms will likely enhance interoperability with other DeFi platforms and conventional financial systems.
Improved user experience
User-friendly interfaces and tools will enhance the DeFi user experience.
Enhanced regulation
DeFi is poised to face increased regulatory scrutiny as it gains popularity.
Emergence of more applications
Expect more DeFi applications, including decentralised insurance, prediction markets, and non-fungible tokens (NFTs).
Integration with other technologies
DeFi will likely interact with cutting-edge technologies like Artificial Intelligence (AI) and the Internet of Things (IoT) to develop new applications and use cases.
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How can Infosys BPM help?
Navigating the intricacies and finding opportunities in the fast-growingDeFi ecosystem demands a strategic partner. Infosys BPM is at the forefront of digital financial transformation, providing customised solutions to assist organisations in leveraging the power of DeFi.
