What Exactly Is Decentralized Banking (And Why You Should Care)

It is well-recognised that blockchain technology has the potential to revolutionise the worldwide economy. In fact, we have already seen considerable progress in this area, with increasing investments in cryptocurrency driving the growth of a bustling transactional industry, primarily consisting of Bitcoin and Ethereum.

Despite the remarkable advances made in the fields of cryptocurrencies and blockchain in recent years, a truly decentralised economy still remains in its early stages. The notion of utilising cryptocurrency as a means of payment or purchase is no longer a figment of the imagination, yet there is still a lengthy journey ahead before its widespread acceptance. To provide some perspective, Turkey is currently the country with the highest rate of crypto ownership and involvement, with 20% of the population having some form of involvement.

It is possible that some believe that the usage of cryptocurrencies will eventually increase. However, despite this, the much-touted economic revolution has not yet come to fruition. It is true that with all the potential implications, local currencies may become replaced with a more universal form of currency. But what if we push the concept of decentralisation even further? This could lead to the development of Decentralised Finance (DeFi), which utilises the fundamental principles of blockchain technology, but is not limited to digital currency.

For Those Who Don’t Know, What Is DeFi?

Before we explore the implications of DeFi, let us first examine what it actually is. According to Philipp Sandner, Professor and author, DeFi is an ecosystem of applications built upon public distributed ledgers, enabling permissionless financial services.

One of the most significant differences between blockchain and traditional financial systems is that blockchain technology utilises decentralised ledgers to provide a comprehensive financial infrastructure, rather than being limited to currencies alone. A world powered by Decentralised Finance (DeFi) would utilise blockchain in a variety of ways, such as for banking services like savings and checking accounts, loans, investments, trade, insurance, and beyond. This would enable the creation of a much more innovative and efficient financial system.

Decentralised Applications (dApps) are an integral part of the DeFi ecosystem, and we have discussed their potential in detail in our blog. A dApp is a distributed software programme that runs on a decentralised system, such as a blockchain, ensuring that no single entity has control over it. As such, dApps have become an increasingly popular way to interact with DeFi services.

A decentralised application (dApp) is one that is hosted across a network of devices (or nodes), instead of being located on a single server and relying on a single team to maintain and update it. Furthermore, dApps are open source and therefore accessible to users across the globe. This is what is referred to as ‘permissionless’ according to Sandner’s definition, meaning that anyone can participate in them. In addition to this, anyone can create a dApp.

Consequently, Decentralised Finance (DeFi) is a financial system that operates via a peer-to-peer network and a suite of decentralised applications. In order for this system to function optimally, we must also include one additional element – smart contracts. If you are familiar with blockchain technology, you will already be aware that smart contracts are responsible for providing the necessary magic. For those who are unfamiliar with the concept, smart contracts are protocols or programmes that can carry out, regulate, or document the details of an agreement.

When entering into a smart contract, all parties agree to the terms and conditions laid out in the same way they would with a traditional legal agreement. The advantage that smart contracts have over traditional agreements is their ability to autonomously monitor compliance with the conditions and rules outlined in the contract. A smart contract is a set of conditions and outcomes which are only fulfilled if certain criteria are met, such as the transfer of funds to a digital wallet, or the issuing of an insurance policy.

The aim of DeFi in developing new and enhanced Decentralised Applications (dApps) is to enable the provision of insurance cover which extends the concept of financial transaction security beyond that of just money transfers. This endeavour seeks to provide a higher level of safety and assurance within the sphere of digital transactions.

In What Ways Is DeFi Unique from More Conventional Forms of Financial Assistance?

Despite its relatively small market share, it is clear that Decentralised Finance (DeFi) is already playing an important role in the development of the financial sector. By utilising a variety of DeFi applications, people now have the ability to bypass traditional banking systems. This has resulted in an increase of activity in the DeFi economy, with individuals engaging in activities ranging from earning cryptocurrency interest to taking out loans and making more sophisticated investments. Consequently, it is evident that DeFi has the potential to provide a great deal of value to the financial sector.

Despite the progress that has been made in the field of DeFi, there is still a long way to go before it can become fully developed. This is largely due to the lack of any corporate or collective body that is actively promoting DeFi. Nevertheless, there is a broad range of individuals and organisations from around the world who are dedicated to advancing DeFi. These include crypto enthusiasts, blockchain experts, and quality assurance outsourcing teams. With this diverse range of perspectives and approaches, there is the potential for both positive and negative contributions to the development of DeFi.

All those invested in Decentralised Finance (DeFi) dApps are determined to make them stand out from traditional banking services. As a result, they offer a range of features and services which are distinct from those usually associated with traditional financial institutions, including:

  • DeFi dApps are self-managing by design. In a traditional financial system, banks and other financial institutions serve as intermediaries to facilitate economic transactions. Decentralised Finance (DeFi) protocols seek to replace these intermediaries with programmable, automated smart contracts. Smart contracts enable decentralised applications (dApps) to regulate all transactions in a trustless environment, with minimal human intervention (although there are still instances where dApps require manual maintenance or upgrades).
  • There are no hidden agendas in this network. There is a great deal of criticism aimed at the current financial system regarding its lack of transparency. By contrast, Decentralised Finance (DeFi) provides an open and transparent environment, where everyone can view and contribute to the development of the core code that supports the likes of smart contracts and transactions. Whilst there may be concerns about the potential risk to individuals’ personal data if it is made public, the use of pseudonyms enables people to remain anonymous when taking part in DeFi activities.
  • Any user, at any moment, may use a decentralised application. Given the global, decentralised nature of DeFi (Decentralised Finance) systems, users can access them from any location with an active internet connection. Moreover, transactions can be made at any time of day or night, as set out in the parameters of the relevant smart contract. This means that users are not limited to the traditional business hours, which can be extremely advantageous.
  • In other words, you don’t need authorization to use DeFi. It is essential to emphasize that, as previously stated, Decentralised Finance (DeFi) is open to anybody with an internet connection. This is due to its permissionless nature. Moreover, all of DeFi’s activities and transitions are subject to the terms of the smart contracts that are designed to regulate them. These contracts are exclusive, unbreakable, and control all transactions.

How Prepared Are We for DeFi?

It appears that the fundamental issue comes down to this: the current banking system could be improved by the adoption of decentralised finance (DeFi), as it offers additional choices, greater access, transparency and security. However, for this to be viable, there needs to be a shift towards global cashlessness and widespread cryptocurrency use. This appears to be a political decision, though DeFi might benefit from some improvements in the event that this is put into action.

It is important to note that modern Decentralised Finance (DeFi) applications do not currently provide crypto loans to those without any collateral. This is due to the lack of a robust identification system that would enable collateral-free loans. As a result, the country continues to rely on alternative methods to guarantee financial transactions. Additionally, there is the vulnerability of smart contracts, which can be exploited by anyone with the technical knowledge to crack the open source code of a decentralised application – a risk that is likely to remain. Finally, a key challenge to widespread adoption of DeFi dApps is the user experience; these applications need to be improved in terms of user experience in order to appeal to audiences outside of the blockchain niche.

Despite the numerous challenges that the Decentralised Finance (DeFi) sector currently faces, the potential for it to become a radical alternative to the current financial system is extraordinary. Although the DeFi sector is still in its early stages, it is not difficult to imagine that it could become the future of banking, provided that the technology and public opinion continue to move in this direction.

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