What is centralized finance
Blockchain technology is behind a lot of innovations that have disrupted traditional legacy industries with new digital services. One of these disrupted sectors is the Financial Services industry. Traditionally, people store their money in their bank account, allowing them to gain a tiny percentage of interest through their savings account. Much of the financial services are dictated by banks; If you need a loan, the bank decides how much you can borrow and the interest rate.
At first, the cryptocurrency industry used pretty much the same structure. But instead of adding assets to a bank, people would allow the exchange to store their assets in a dedicated personal wallet held on an exchange. By doing this, users could trade for different assets and send funds to other exchanges and other users’ wallets. However, storing assets on a centralized exchange also means that you don’t really own your assets, as the exchange itself controls the private keys that provide control of the assets.
The exchange also controls what tokens you can trade and how much fees you need to pay.
So, for definition purposes, traditional financial services with banks or even central crypto exchanges are referred to as Centralized Finance or CeFi.
Introducing Decentralized Finance
With Decentralized Finance, DeFi, no central exchange is involved. Instead, Instead, the users interact with an automated computer program known as a smart contract on the blockchain that creates a peer-to-peer market, allowing people to bypass the need for bank accounts to trade cryptocurrencies, lend or borrow funds, and earn interest through various yield opportunities. In other words, you pretty much become your “own” bank.
One of the major benefits of DeFi compared to CeFi is that the user has full control of his assets and the keys for the private wallet that is used to access the platform. Any user who wants to access Decentralized Finance will have to connect to a DeFi platform through a Decentralized Application (DApp) which is an app built on the blockchain. Later in this series, we’ll go through examples of DApps that are commonly used on the market today.
Decentralized Finance is surely one of the most exciting innovations that blockchain technology has enabled. The DeFi market has grown very rapidly over the last 12 months. By October 2020, over $11 billion dollars was deposited in various decentralized finance protocols, representing more than a tenfold growth during 2020. As of January 2021, approximately $20.5 billion dollars were added to DeFi, and just one month later, in February 2021, it’s well past $40 billion dollars.
To conclude, DeFi is experiencing exponential growth, and this is only the beginning. The DeFi financial disruption begins a new era in the Financial Services industry.