Newer versions of technology have sprung up over the years, following the invention of the first blockchain ledger in 2009. These technologies include web3, smart contracts, cryptocurrencies, and Defi.
Put simply, decentralized finance is an open form of finance in which the need for banks and middlemen is eliminated. Decentralized finance or Defi involves financial products and services, running on software built using blockchain technology.
While the traditional financial system is on a centralized platform known as Cefi and is controlled by governments or corporations, Defi runs on a decentralized infrastructure, powered and supported by the blockchain.
In centralized finance, users put their money and assets in banks. The problem with this is that a bank's primary aim is to make money.
Transacting with banks might involve middlemen and other facilitators, each one charging a certain amount for their services. This can mean hours of tedious paperwork when applying for loans, long waiting hours, and high transaction fees in total.
Centralized finance while having benefits like insurance and security, can have rather glaring disadvantages.
For example, banks and financial institutions can inflate the money supply or confiscate the assets of their customers however they see fit. None of which apply to the decentralized form of finance.
Decentralized finance, on the other hand, is the complete opposite of centralized finance. Decentralized finance eliminates the need for middlemen, allowing for peer-to-peer (p2p) transactions between users.
With decentralized finance, anyone with an internet connection can buy, sell, lend or borrow financial assets. The need for a transparent, open, and universal financial system was the key driving factor for the development of decentralized finance.
The original goal of Defi is to reconstruct the banking sector into a resilient, open, permissionless, and transparent space. Considering all the downsides to centralized or traditional finance, the need for a switch to a partially or completely decentralized form of finance has become all the more compelling over the years.
There is no central body in the world of decentralized finance. Thus, anyone can create decentralized applications, smart contracts, buy and sell, or borrow and lend.
A glaring and quite problematic disadvantage of this kind of system is that the lack of regulation as is the case with Cefi makes decentralized finance prone to hacks and scams. This means that the assets of users in a decentralized financial system are more likely to be stolen by hackers and scammers.
Traditionally, decentralized exchanges have been forced to pay hefty fees to liquidity providers such as banks and other centralized financial institutions. None of that would be the case if the gaps were properly bridged.
There are a few steps to take if a new financial system that represents the core values of both Defi and CeFi is to come to light. Some of which include:
There is still a long way to go if the gaps between Defi and Cefi are to be bridged. Both have equal advantages and disadvantages. A platform that has all of these advantages and only a few of the disadvantages would be a major step in the right direction for everyone.