How DeFi is changing the economy and cryptocurrency ecosystem

The current world economic system has left many 'wanting for more. Countries have seen economic upticks and downturns. A 2019 report by World Vision has revealed that 689 million people in the world live in poverty.

Also in another event, the Global Findex report in 2017, it was noted that more than 1.7 billion adults lacked banking access. The injustice and retardation in finance is caused by successive financial decisions and crises made by the governments; a good example is the financial debacle of 2008, when government US decisions plung the whole world into recession.

Its no news that governments control economies by printing money, which at times leads to devaluation of currency and decreasing money's purchasing power, taxing more of the money of the middle class, altering business taxes to impact job creation, and most times manipulating and varying interest rates to their advantage. They give no or less concern to the common people when it comes to these crucial financial decisions, making them resort to alternatives.

Well, Bitcoin (created by Satoshi Nakamoto) and cryptocurrency came in as an alternate option; this new form of currency (Bitcoin) did well in eliminating financial intermediaries. Although Bitcoin had some lapese, that is, when it comes to economics, it did not provide crucial financial services such as loans, protection, portfolio management, and a lot more, but that was where DeFi came in.

Decentralized finance (DeFi) seeks to address these issues with blockchain, smart contracts, and decentralized applications (dApps). DeFi provides open financial tools to everyone on the entire globe. From lending to insurance and trading of assets, DeFi is revolutionizing finance, providing more control over individual money beyond institutions.

By the end of this article, you will gain knowledge of the basic notion and meaning of decentralized finance, coupled with its wide range of services and applications. In addition, they will be informed of the impact of decentralized finance on the cryptocurrency market, in addition to its effects on the overall system of economics, while also looking at a range of platforms that provide entry to such decentralized financial services.

The article will also shed light on potential challenges facing decentralized finance, hence providing a complete analysis of its challenges and potential.

The definition of DeFi

DeFi is a blockchain-based financial technology that does not depend on known financial intermediaries like banks, insurance companies and brokers but instead uses smart contracts (most likely Bitcoin and ethereum) to execute transactions.

Some DeFi platforms allow users to borrow and lend funds to each other (P2P lending), earn interest throughs savings accounts, insure against risks, speculate and place bets on prices, events etc.

DeFi offers an entirely new world of finance to users in the cryptocurrency ecosystem. The goal is to create alternate finance where anyone with an internet connection can access funds and experience bank-like transactions.

The 4 basic foundations of DeFi are:

• Cryptography
• Decentralised Infrastructure
• Smart contracts
• Digital currency

Cryptography and Decentralized Infrastructure:

Cryptography and cryptocurrency are the foundation of DeFi. Cryptography gave birth to the idea of decentralized infrastructure.

The decentralized structure would act as a record book, database, or ledger for recording cryptocurrency transactions.

The bitcoin blockchain is the first primary decentralised ledger; it is responsible for authorising, authenticating, verifying and recording all bitcoin transactions with the help of individuals known as

Miners

The miners are responsible for certifying bitcoin transactions; the miners receive bitcoin for each successful block of transactions they process.

This singular action limits the application of bitcoin blockchain as default in DeFi because the need for miners to verify transactions betrays the whole idea of decentralization and the effect of intermediaries in traditional finance.

Also, the bitcoin blockchain features basic programming functionalities that limit additional features and are not compatible with DeFi; the Ethereum network solves these problems.

Vitalik Buterin created the Ethereum network to solve the problems associated with bitcoin's blockchain. The Ethereum blockchain:

• Is Programmable
• Is a 'Do-it-Yourself' service (DIY)
• Allows the implementation of Decentralised apps (Dapps)
• Permits the use of Smart contracts

Smart contracts

Another basic foundation for DeFi is Smart contracts; Smart contracts are self-executing programs that implement a transaction according to the terms of agreement or contract.

They are codes meant to execute a set of actions between a buyer and seller after meeting some conditions.

Smart contracts take over intermediaries, banks, and the government to make a financial transaction.

The populace buys into the world economy and makes investments because of the trust placed on the government and other corporate bodies.

Smart contracts assure DeFi users of that trust because smart contracts are automated and cannot execute when a condition fails.

After deploying a smart contract code, the owner will lose control because smart contracts are immutable.

Smart contracts enable DeFi by delegating the role of the government or corporate bodies to immutable lines of code.

Digital currency

Every financial infrastructure needs a currency or money as a medium of exchange for transactions.

Though the whole idea of DeFi erupted from the creation of the Ethereum network, common sense would require that Ether (the default currency in the ethereum network) should be the default currency in DeFi.

The above cannot be the case because Ether is very volatile. A very volatile currency would not ease the fear of investors and future DeFi users.

Stable coins like USDT, USDC, DAI etc., are the default currencies in DeFi because their value is pegged to the US dollar and are less volatile.

DAI is the common cryptocurrency used. Unlike USDT, DAI is overcollateralized with other cryptocurrency assets in reserve.

On the contrary, USDT maintains its value with USD cash reserves; thus, the government reserves little control over the value of USDT.

Applications and uses of DeFi

As stated earlier, DeFi seeks to take over the role of traditional finance. In the journey to achieve such fit, potential users would always ask about the benefits, uses and applications of DeFi.

DeFi offers loads of opportunities and benefits to users.

Some of the applications and uses of DeFi competes with traditional finance is, being a bank for the everyday person, with the only difference being the foundational infrastructure and architecture.

A whole lot of research, testing and developments are underway to create more opportunities with the use of DeFi, but some of the known services and applications of DeFi are:

• Anonymity and less regulation
• Decentralized applications (Dapps)
• Borrowing and lending of cryptocurrencies
• Insurance
• Decentralized exchange
• Flash loans

Anonymity and less regulation:

Today, the government dictates policies either to impact the economy or to abuse its power. The government determines the total amount of transactions a citizen can perform daily. They also limit access to foreign investment whenever they deem fit.

In some cases, the government prevents forex transactions while giving access to only a handful of people. DeFi gives everyone access to a wide range of financial benefits devoid of regulation.

Users are allowed to move an unlimited amount of funds in cryptocurrency assets while using DeFi. DeFi does not promote the KYC policy because the government does not regulate it.

This advantage ensures that users are not over-taxed for performing simple transactions.

Decentralized applications (Dapps):

Decentralized applications or Dapps is are one of the core uses of DeFi. The ethereum network allows Software developers to create decentralized apps on the ethereum chain.

All decentralized apps have no central authority but rather use smart contracts to execute actions and validate transactions.

Dapps are broadly used in DeFi to provide financial services to users. Traditional finance services like borrowing, lending, margin trading, exchanges, etc., are accessible to users through Dapps.

Uniswap is one of the most popular Dapps hosted on the ethereum network. Uniswap automates exchange of cryptocurrency based on the smart contracts model. Users could also use the Pancake application for the same purpose.

Borrowing and lending of cryptocurrencies:

Traditional financial institutions like banks and other fintech companies keep the economy afloat by lending money to individuals and companies.

These loans often come with a high interest rate. Many a time, only a few individuals are eligible to get loans from banks.

DeFi, on the other hand, has opened a new space for users without prejudice or bias on gender, age, race or social class. With DeFi, users can easily take loans on stable coins to make a trade and other transactions.

DeFi also allows users to earn interest on their cryptocurrency assets by lending to other users. AAVE is one of the known platforms that seeks to connect the borrower and the lender.

The interests on DeFi loans are low because of the competitive market - many users are willing to loan their crypto assets and earn in the process.

Insurance:

Daily activities come with risks, which is why people opt for or buy insurance packages to mitigate unforeseen circumstances. Insurance payments are by premiums.

DeFi has delved into the insurance niche to offer insurance packages in the real world. With platforms in DeFi, users can buy insurance packages to protect their farms etc.

For instance, Software developers could deploy smart contracts codes to make insurance payments to a user if the temperature in a particular region is above a chosen degree Celsius. Oracles determine this decision.

Some DeFi insurance providers like Nexus mutual, Opyn and others offer coverages against market volatility, wallet hacking, etc.

Decentralized exchange:

As noted earlier, Dapps accesses borrowing, lending, insurance, and other services. Some Dapps offer services in cryptocurrency exchanges.

In traditional finance, Forex is the transfer of foreign currency from one point to another. Decentralized exchange (DEX) offers a platform for exchanging or swapping cryptocurrencies.

For instance, a user can exchange ethereum for bitcoin in Uniswap or Pancake applications. DeFi offers DEX to allow interaction between the different coins and tokens available.

Flash loans:

Flash loans are one of the most innovative applications of DeFi. Flash loans are the first uncollateralized loans in DeFi.

At the moment, flash loans are accessible to only developers. Smart contract protocol is the foundation of flash loans. It allows developers to borrow millions of dollars worth of crypto assets and repay within seconds.

For example, if Ethereum is sold for $1 on Binance but sold for $1.2 on Coindirect. smart contracts can allow a developer to borrow $10 million worth of ethereum from a DeFi platform to buy ethereum on Binance and sell it instantly on Coindirect for a higher price.

If inadvertently, the price in Coindirect slips below the proposed order, the transaction would fail, and the loan returned instantly to the DeFi pool—that is, smart contracts in play.

Conclusion

DeFi has given us fresh financial possibilities through its system, but not without possible challenges and minor dangers. People view DeFi either as a revolutionary change, but still doubt its prospects.

The insurance product raises sustainability concerns because of its unclear terms combined with cryptocurrency's unpredictable market behavior.

Users must accept total responsibility for their transaction mistakes since DeFi lacks any shared intermediary system. Unsecured flash loans create opportunities for exploitation, which results in fund losses.

But nevertheless, the growth of DeFi continues at a rapid pace while presenting various financial growth and upgrades to its users. It is advised that enthusiasts should research before investing.

DeFi will inevitably transform the future economic environment into a new system that may show both positive and negative effects.