Decentralized Finance: Laying the foundations of future financial systems
Decentralized finance or DeFi offers a markedly different experience to traditional banking. Existing centralized systems limit the speed, flexibility, and transparency of transactions, giving users less control over their money. DeFi on the other hand, removes the need for financial bureaucracy, offers users numerous benefits that go far beyond just finance and opens up a world of possibilities previously closed to consumers. The concept has been gaining traction over the past couple of years, with billions of dollars invested in its ecosystem since 2020. The growth is mainly led by applications that are built on the Ethereum blockchain, and offer multiple benefits to users.
The decentralized, permissionless nature of Ethereum-based applications removes entry barriers for users and presents quicker, more efficient interactions. Existing consumer banking is slow and requires lengthy paperwork even if one is simply looking to close a bank account. In contrast, DeFi’s competitive markets move quickly and efficiently. Given that all DeFi applications share the same database, projects compete fiercely on fees and try to offer the best user experience. Additionally, the transparent, auditable nature of capital reserves in DeFi enables users to efficiently manage their transactions and undertake rigorous risk assessments.
In addition to crypto transactions, DeFi is also impacting the way we exchange goods and services online. The recent emergency of decentralized exchanges (DEXes) facilitates peer-to-peer trading of digital assets in an easy, efficient way. This concept is now being expanded to include traditional financial instruments and even physical goods and services. For example, the use of smart contracts in agrarian marketplaces eliminates middle-men and intermediaries and creates new ways for people to buy, sell, rent, and trade their goods. DeFi helps improve due diligence, offers greater transparency and makes it easier to identify and track transactions as they are all based on blockchain. This has proved to be a big deterrent against nefarious behaviour.
Among the many positive outcomes of creating financial services on a transparent, shared database is that all associated transaction data is publicly available in real time. Investors can consequently, use this data to decide how to allocate resources and capital more efficiently, while regulators can monitor real-time transaction data to identify fraudulent activity. Given its novel innovations around settlement efficiency, risk management, and accessibility, it is clear that DeFi will pave the way to more efficient financial systems in the future.
This article written by Shahzad Fatmi, CEO at SettleMint India
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