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

The transformative potential of blockchain technology in the global economy is widely acknowledged. Currently, we are witnessing significant advancements in this field, as the cryptocurrency market continues to boom, with Bitcoin and Ethereum dominating the transactional industry.

Despite significant progress in the fields of blockchain and cryptocurrencies, a fully decentralised economy is still in its infancy. While it’s no longer just a theoretical concept, the widespread adoption of cryptocurrency as a viable method of payment or purchase still has a long way to go. For instance, Turkey currently has the highest rate of crypto ownership and involvement, with only 20% of its population having some sort of involvement with it.

While some may have high hopes for the adoption of cryptocurrencies in the future, the anticipated economic revolution has yet to materialize. It’s feasible that one day, local currencies will be replaced by a universal form of currency due to the potential implications. However, what if we take the concept of decentralisation one step further? This could lead to the creation of Decentralized Finance (DeFi), which utilizes the essential principles of blockchain technology, but is not restricted to digital currency.

What Exactly is DeFi?

To better understand the potential ramifications of DeFi, it’s essential to define what it entails. Philipp Sandner, a professor and author, describes DeFi as an array of applications operating on public distributed ledgers, which permit financial services to be conducted without permission.

One of the key distinctions between blockchain and traditional financial systems is that blockchain technology utilizes decentralized ledgers that can offer a comprehensive financial infrastructure. Consequently, a world fuelled by Decentralized Finance (DeFi) would integrate blockchain in a plethora of ways, including but not limited to banking services such as savings and checking accounts, loans, investments, trade, insurance, and more. This would result in a much more innovative and efficient financial system.

In the realm of DeFi, Decentralized Applications (dApps) play a vital role, as we have previously examined in our blog. A dApp is a software program that runs on a decentralized system like a blockchain to ensure that no singular entity has authority over it. Due to this, dApps have emerged as a trendy means to engage with DeFi services.

Unlike an application hosted on a single server that depends on a single team for maintenance and updates, a decentralized application (dApp) is spread out across a network of devices (or nodes). Additionally, dApps are openly accessible to users worldwide due to their open-source nature. This aligns with Sandner’s definition of ‘permissionless’, which implies that anyone can participate in them. Moreover, anyone can create a dApp.

In essence, Decentralized Finance (DeFi) is a financial system that works via a peer-to-peer network and a range of decentralized applications. However, to ensure this system operates optimally, we must include an additional element – smart contracts. If you’re already familiar with blockchain technology, you’ll know that smart contracts play a significant role in its functionality. For those who are new to the concept, smart contracts are protocols or programs that can execute, govern, or document the details of an agreement.

When engaging with a smart contract, all parties involved consent to the terms and conditions specified, just as they would with a conventional legal agreement. The primary advantage of smart contracts over traditional contracts is their capacity to independently monitor compliance with the contract’s conditions and regulations. Essentially, a smart contract is a collection of predetermined parameters and outcomes that are only executed if certain criteria are met, such as the transfer of funds to a digital wallet or the issuance of an insurance policy.

The goal of DeFi in creating innovative Decentralized Applications (dApps) is to broaden the concept of financial transaction security beyond that of just money transfers by providing insurance coverage. This endeavor aims to elevate the level of safety and assurance within the realm of digital transactions. (Read more)

What Sets DeFi Apart from Traditional Forms of Financial Assistance?

Despite its comparatively small market share, there’s no denying that Decentralized Finance (DeFi) has already made significant contributions to the financial sector’s progress. By leveraging a range of DeFi applications, individuals can now circumvent conventional banking systems, resulting in an uptick of activity within the DeFi economy. Transactions vary from earning cryptocurrency interest to procuring loans and making complex investments. Overall, DeFi has the capacity to add significant value to the financial sector.

Despite the strides made in DeFi, it has yet to reach its full potential because there lacks a corporate or collective entity actively promoting its progress. Nonetheless, there exists a diverse range of individuals and organizations worldwide committed to advancing DeFi, including crypto enthusiasts, blockchain experts, and quality assurance outsourcing teams. The multiplicity of perspectives and approaches, however, carries the possibility of both constructive and destructive influences on DeFi’s development.

Individuals committed to Decentralized Finance (DeFi) dApps strive to differentiate them from conventional banking services, with an array of features and services unique to DeFi, such as:

  • Self-management is inherent in DeFi dApps.

    Conventional financial systems rely on banks and other financial institutions to facilitate financial transactions. Decentralized Finance (DeFi) protocols, on the other hand, aim to replace these middlemen with programmable, automated smart contracts. Smart contracts facilitate the regulation of all transactions within a trustless environment, allowing decentralised applications (dApps) to function with minimal human intervention (although there are still instances in which dApps require manual maintenance or upgrades).
  • Transparency is a fundamental characteristic of this network.

    The current financial system has been subject to criticism for its opacity. In contrast, Decentralized Finance (DeFi) provides an open and transparent environment, where individuals can access and contribute to the core code that underpins smart contracts and transactions. While the idea of personal data being made public may raise concerns, the use of pseudonyms allows individuals to partake in DeFi activities anonymously.
  • Decentralised applications are available to any user, anytime.

    The global and decentralized nature of DeFi (Decentralized Finance) systems allows users to access them from any location with an internet connection. Transactions can be executed at any time of day or night, based on the specifications of the smart contract. This eliminates the constraints of traditional business hours, offering significant benefits to users.
  • DeFi usage doesn’t require authorization.

    As noted before, Decentralized Finance (DeFi) is accessible to anyone with an internet connection, thanks to its permissionless nature. The activities and transactions within DeFi are governed by smart contracts that regulate them. These contracts are exclusive, unalterable, and exercise control over all transactions.

Are We Ready for DeFi?

It seems that the crux of the matter is this: the current banking system could benefit from the integration of decentralized finance (DeFi) due to its added options, enhanced accessibility, transparency, and security. However, realizing this potential would require a transition to universal cashlessness and cryptocurrency adoption. This seems like a political decision, but should it be implemented, DeFi could benefit from these developments.

It’s worth noting that present-day Decentralized Finance (DeFi) applications don’t provide collateral-free crypto loans as they lack a robust identification system. Consequently, the country continues to rely on alternative methods to ensure financial transactions. Furthermore, smart contracts are susceptible to exploitation by anyone with the technical know-how to break into the open source code of a decentralized application, an ongoing risk. Lastly, the user experience of DeFi dApps presents a significant adoption hurdle as these applications must improve their user-friendliness to expand their appeal beyond the blockchain domain.

Despite the manifold challenges plaguing the current Decentralized Finance (DeFi) sector, its potential to emerge as a transformative alternative to the current financial system is striking. Although it is at an nascent stage, envisioning DeFi as the future of banking isn’t a far-fetched notion, given the direction of technology and popular opinion.

Join the Top 1% of Remote Developers and Designers

Works connects the top 1% of remote developers and designers with the leading brands and startups around the world. We focus on sophisticated, challenging tier-one projects which require highly skilled talent and problem solvers.
seasoned project manager reviewing remote software engineer's progress on software development project, hired from Works blog.join_marketplace.your_wayexperienced remote UI / UX designer working remotely at home while working on UI / UX & product design projects on Works blog.join_marketplace.freelance_jobs