If you're interested in blockchain, you may already know about decentralized finance, also known as DeFi. Will DeFi become an affordable, secure, and convenient alternative to traditional banking in the near future. Let's break it down.
What is DeFi (Decentralized finance)?
Decentralized finance takes advantage of the decentralization of Blockchain technology to create a peer-to-peer cryptocurrency network where users can store and trade their assets digitally - without intermediaries. Transactions become transparent, cheap and open to anyone with an internet connection.
DeFi operate based on four key concepts:
1. Smart contracts. In the blockchain, smart contracts are encrypted for validation and automatic execution. They cannot be used or changed.
2. Decentralized funding protocols. Protocols combine multiple smart contracts to align them with real-world situations and accomplish specific tasks.
3. Management tokens. Decentralized finance projects use cryptocurrencies as governance tokens to allocate authority and rights to users. For example, users can vote to change protocols, operations, project incentives, etc.
4. Decentralized Application, or dApp. The application runs on a network of peer-to-peer computers or on a blockchain to help interact with protocols.
Differences between DeFi and traditional bank
Accessibility - To open an account, users have to go to traditional banks, visiting a physical office that may be far away and their opening hours are limited. Instead, DeFi platforms are available to anyone connected to the internet - anywhere and anytime.
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Money ownership - in both cases, the money belongs to you. However, if you use conventional banks, the funds are held on the bank's side and you need to contact the bank for any transactions. In case of any irregularities, banks can block you from receiving the money.
When you use DeFi platform, you get full control over the funds, i.e. you decide where and how to spend the tokenized money.
Intermediaries and Processes - The most significant difference between DeFi and a traditional bank is the involvement of intermediaries. Banks have intermediaries and a lot of manual processes that stretch some money transfers for days. DeFi platforms eliminate intermediaries completely and replace them with automated smart contracts. This way, users can complete DeFi transactions in minutes and with increased transparency.
Security
In theory, both bank transactions and DeFi transactions are secure. However, banks have tightly controlled processes to facilitate your money, there are many regulations in place to protect your rights and assets with banks. DeFi utilizes secure blockchain technology. The data in the blockchain is tokenized and is virtually impossible to change.
There are virtually no regulations on DeFi, which means there is less consumer protection than traditional banks. As of today, cybercriminals are trying to hack and steal data for their own purposes on a daily basis. They have already hacked several DeFi projects and caused hundreds of millions of dollars in damage.
Conclusion
Although there is no comprehensive legal framework for DeFi right now, the process of creating such a legal framework is underway. FinTech and distributed ledger technology are being discussed not only among technology enthusiasts, but also among leaders of the G20 countries.
In June 2021, the World Economic Forum presented the Decentralized Finance (DeFi) Policy-Maker Toolkit, which provides an overview of the DeFi space, considers its potential benefits and risks, and outlines possible legal and regulatory measures for DeFi. And in March 2023, Europe prepared an AML law for the crypto industry.
