DeFi was the first time announced to the public in 2018. However, it was not until 2020 that the community noticed this phrase through a DeFi Summer event. The total value locked in DeFi also reached more than 150 billion USD with the participation of many traditional investment funds.
So, what is the definition of DeFi and how can it change the whole world of finance? Let’s find out with FinFan.
What is DeFi? How does it work?
The definition of DeFi
DeFi is the abbreviation of Decentralized Finance that is created by the Smart Contract of blockchain. Thanks to the decentralization of blockchain, users have full control over their assets (non-custodial) in DeFi applications. This helps DeFi move towards Open Finance.
How does it work?
DeFi contains the suffix finance in the definition. For that reason, it can work as CeFi (Centralized Finance/Traditional Finance) and operates in the following areas:
· Cryptocurrencies
· Institutions
· Payments
· Finance Services
· Transactions
However, the biggest difference between DeFi and CeFi comes from its prefix Decentralized. That means it can work without the handling of a third party. It can be:
· Non-Custodial
· Permissionless
· Trustless
· And the most important is Decentralized.
How this biggest difference between CeFi and DeFi can change the financial world?
How does Traditional Finance work?
Looking back at the development of the financial market that has taken place over hundreds of years, has undergone 4 major changes:
· Simple or incidental form of value: When one good incidentally reflects the value of another good
· Total or extended form of value: When many goods have the ability to become equivalent objects to express the value of a certain good.
· Common form of value when a good acts as a common equivalent to express the value of all other goods.
· There are many types of goods that have been used as common equivalents such as cattle, copper, silver, gold, and especially fiat money (which is the most commonly used currency today).
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We can realize that in order to exchange material goods between two people or two institutions, people always need to have trust and entrust a third party to do this for them.
Just like in history when people wanted to exchange goods with objects of equal value, everything had to go through a third party to be able to determine whether the value of those things was equal to each other or not. This third party is often also the supplier of that equivalent item.
The most typical example of parity is the current legal currency that countries are using, which was created by a number of powerful groups of people and has the ability to control and control financial games around the world. world such as the Central Bank or the State Bank.
Particularly in the US is the US Federal Reserve (which is not part of the US state, but an independent private financial organization set up by some financial forces).
Till today, the US dollar is still the most powerful international currency in the world, although its manipulative nature has been clearly seen through changing values through standard regimes from gold to oil (which benefits the capitalist entrepreneurs at the top of the Fed).
Can an individual or small financial institution change the value of these equivalents? Mostly it is impossible because only authorized agencies have the right to issue and change their value.
Even a few US Presidents have died due to the policy of opposing the capitalist regime set by these financial-dominant private parties.
How DeFi can change the financial world forever?
If delegation and empowerment are the underlying problems of traditional financial markets, then DeFi can totally solve the aforesaid problem.
In traditional finance or Traditional Finance: Organizations, markets, and financial instruments always exist as intermediaries with centralized power. Meanwhile, DeFi leverages the power of Blockchain's transparency and decentralization to eliminate these intermediaries. Specifically:
· Governments or banks (CeFi) will be replaced by decentralized blockchains.
· CeFi assets will be replaced by tokens located in the Blockchain ecosystem and they are decentralized.
· DeFi's mission is to provide access to financial services for users anywhere, anytime as long as they have the Internet ⇒ This demonstrates the unique openness of DeFi (Open Finance).
The nature of DeFi is expressed through three properties: dispersion, decentralization and transparency. Therefore, transactions between the sender and recipient will be directly confirmed by a Smart Contract between the two parties.
For example, if you want to sell a painting to buyers on OpenSea, in fact this platform can only support you in listing and auctioning that painting and they do not charge any costs (except fees) from you or the buyer.
All of the above transactions are performed through a Smart Contract between two parties through cryptocurrency wallets and both parties receive transaction notifications before pressing the button to agree to payment. Buyer will immediately own the token of that painting and you will receive the corresponding cryptocurrency (possibly ETH or a currency that you have chosen to value from the beginning or is the platform for them to generate tokens).
The second special point is that all transaction information between the seller and the buyer is encrypted. So even if hackers find information, they cannot understand and translate it. An example encoding for a transaction will appear as the following code:
0000000000000000e067a478024addfecdc93628978aa52d91fabd4292982a50
With centralized finance, because it is managed by a third party, all transactions are displayed in very detailed and complete information about both parties for convenient management.
However, when central banks and financial institutions are replaced by tokens or coins, everything encrypted does not necessarily translate into official information anymore.
In short, applying DeFi to transactions will help transactions take place faster and cost less intermediary fees. However, without the intervention of an authorized third party, DeFi transactions can easily be used by illegal organizations to launder money or have nefarious transactions.
To solve the above problem, solutions have been implemented in the form of KYC/KYB or checking with the AML system to reduce risks when performing the above transactions.
