Decentralized Finance and its Impacts on the Future of Fintech

Introduction:

FinTech has empowered digital innovation and democratized access to financial services for millions of people across the globe. As we progress further into the Digital Age, financial services are becoming increasingly digital, secure, and connected through the internet. This dynamic ecosystem where all financial services build & operate on blockchain technologies without human intervention is called Decentralized Finance.

In recent years, we’ve seen the emergence of this online marketplace that provides frictionless access to capital. These peer-to-peer networks and smart contracts are shifting power away from traditional financial institutions and decentralizing control over money once locked inside centralized institutions like banks and investment firms. As a result, fintech innovators are now able to build software that directly connects lenders with borrowers on an open, transparent exchange — essentially replacing old-school intermediaries with code.

What is Defi?

Decentralized Finance (Defi) is the process of moving traditional financial services off of centralized, managed platforms and onto decentralized and open networks that are controlled by the community. It has grown and evolved since the rise of blockchain technology and the emergence of cryptocurrencies however, got special attention in 2018 as a Defi. It got special attention It is a new way of thinking about how to manage money and build financial services. It also represents a shift in the way that people interact with the financial system. Whereas traditional finance is centralized, inefficient, and opaque, Defi is open, efficient, and transparent.

What is driving the growth of the Defi ecosystem?

The growth of Defi is largely being driven by a need for more efficient and transparent financial services. For example, large numbers of people are currently underbanked or unbanked in the world. This is largely due to the fact that financial institutions don’t have the resources to effectively serve everyone. In the past decade, the industry has seen the rise of powerful new technologies, such as blockchain and distributed ledger technology, which have redefined the landscape for decentralized finance.

Decentralized Finance is Different from traditional Financial Institutions:

Defi is as the name suggests, it's way different from traditional centralized finance. Defi redefines Fintech by addressing problems of the existing financial systems and providing solid grounds for sustainable innovation in the Fintech space. Decentralized Finance is a new approach to financial services that aims to reduce inefficiencies and unlock new forms of value-creating activities for participants. In short, it’s about democratizing control of money and bringing it back to the people who own it. In the traditional system, banks and financial institutions hold the power to decide who receives loans and at what rates. They also control the flow of money through their centralized systems. Decentralized finance is a new approach to managing money.

How is Decentralized Finance Re-defining the Future of Fintech:

Decentralized Finance is bringing the future of fintech into reality. It is helping to create a new landscape of financial services that is more efficient, transparent, and accessible to all. Defi is fundamentally changing the way that money is being managed and distributed. It’s also sparking a conversation around the idea of a truly decentralized financial system — one that is free from centralized institutions and governed by code. It is also bringing fresh challenges and questions about long-term sustainability. While blockchain technology and the open source communities powering Defi platforms are incredibly innovative, they often lack the support required to sustainably scale and maintain platforms.

Problems with Existing Banking System:

The core function of banks is to facilitate transactions, well banks are better in local transactions but for international transactions, it's still poor, requires a bundle of docs, waits for hours to days, and has heavy fees. There is a hell of rules and restrictions in the existing system for cross-border transactions due to the central bank’s intermediations and varying policies and laws from country to country.

Defi's goal is; Borderless accessibility of all financial services to every human. A transaction through Defi needs a few seconds and the wallet address of the next person regardless of where he belongs to. Moreover, transactions are transparent to users at every single step.

Potential Benefits of Decentralized Finance:

Decentralized Finance has many benefits for all stakeholders involved — whether you’re an investor, borrower, or someone who simply wants to use the service. Some of the potential benefits include lower interest rates, increased transparency, and better access to capital. The emergence of decentralized finance has the potential to shake up the financial services landscape by unlocking new sources of capital from an untapped pool of investors — including individuals and institutions. Decentralized finance provides a way for people to directly connect with these other potential investors, cutting out intermediaries to find better interest rates and more transparent loan terms.

Following are the few unique features of Defi;

Accessibility:

Universal accessibility is the main goal of Defi. Until today even basic banking services are not available to more than 2 billion people in the world. Defi will create a more inclusive world by providing all financial services to every child of God. The world elite has a monopoly over the existing financial system and only upper-tier citizens enjoy most of the financial services, which increases the income gap between the rich and poor.

Defi provides easy access to all financial services and more for free or with minimum cost. Investing, trading and future preps of assets on DEXs (decentralized exchanges like Binance, Bybit, etc.) are very fast and easy. Unlike regular stock exchanges, it doesn’t need prior approvals from authorities, a bundle of files, salary slips, brokerage firms, days for settlements, heavy fees, etc.

Similarly, other services like, Lending, Borrowing, Stacking assets, taking Flash loans, Yield farming, participating in Liquidity pools, and insurance services will be very easily available to everyone.

Transparency:

Defi is more transparent; transaction history is available to users, no hidden fees, and fear of data theft. Traditionally banks remained controlling authorities that keep changing fees and hold private data, which they can sell to agencies as well. Complex financial products; like investment, bonds, fixed deposits, insurance, asset trading, lending, and borrowing are available to some extent in Defi. Although innovation, adoption, and time will make all these services more advanced, safe, and globally available.

Self-ownership:

Defi gives the very concept of self-ownership of assets and money. Without interventions from central banks, regulatory authorities, and state agencies an individual is the sole owner of his money in Defi. No institution can withhold even a single penny of any person. Everything operates on smart contracts and algorithm that couldn’t change without approval from thousands of stakeholders of that contract(nodes). The financial environment becomes more liberal and safe for individuals in this way.

Data security:

Financial data is very important and personal. Everyone wants to keep it secure and private. It’s impossible when big giants track you round the clock. Many times data got leaked, manipulated, and stolen from databases of financial institutions and central banks. Defi ensures full security of personal data through blockchains and smart contracts, only you own your data. To access data it needs approval from the owner and the algorithm of hundreds of thousands of blocks needs to be changed at the same time to manipulate data.

Financial Creativity:

Open-source blockchains encourage more creativity in the fintech space. Professional and talented people are freely creating, and launching their products. Good projects can get funding from global investors through ICO (initial coin offerings), and individuals can create content and sell globally without the fear of theft or copyright issues i.e NFTs. The unique feature of blockchain is its immutability, which provides a competitive and equal playing field for everyone.

Innovative solutions:

In the Defi space, people are working to create a more inclusive world by providing equal financial opportunities to developing countries which the traditional system has failed to address. Taking loans, and access to financial markets is very difficult without credit scores. Acquiring capital is very difficult in developing countries for new businesses. In the Defi space, people are working to build innovative products to solve the global problems of humanity, i.e. Goldfinch a Defi project working to make it possible for small businesses to get crypto loans without crypto holdings through lending protocols.

The Solution to Global Financial Problems:

Hyperinflation and currency devaluation, due to unnecessary currency printing by central banks have remained a big problem. The financial crisis of 2008 pushed millions below the poverty line and hundreds of thousands lost their life fortunes because of the existing financial system. Defi prevents currency manipulation, and resultantly hyperinflation. It proves to be a reliable system for circumventing current flawed practices of financial institutions.

Counters Censorship:

Unethical and unwanted restrictions by govts. on using financial services in many countries has remained a centuries-old issue. Blockchain integration to many financial products (like Ripple) solves this problem by circumventing restrictions from oppressive govt. Defi provides full access to all financial products and services and restricts unnecessary privacy breach by authorities.

Benefits for Borrowers and Investors in using Decentralized Finance platform?

Borrowers:

When lenders and borrowers connect on a decentralized finance platform, they can set the terms of their contracts and directly determine the interest rate. This means that borrowers have more control over their loan terms and don’t have to rely on a centralized organization to make those decisions for them. Decentralized finance also brings greater transparency and visibility to the transaction, which allows borrowers to build trust and communicate the purpose of their loan with lenders. Banks need collaterals, heavy interest, past records, credit scores, and many docs for loan applications. Then wait for months to years for loan approval to small businesses or individuals. On the other hand, Defi loans will be provided quickly within seconds by just providing other crypto assets as collateral. There will be more equality without any central authority that judges the rich and poor differently.

Investors:

Investors on Decentralized Finance platforms can access more investment opportunities and participate in a broader range of loans. Many Defi platforms also offer tokenized assets and enable investors to manage risks by investing in diversified portfolios of loans. These platforms also enable investors to contribute a smaller amount, in dollar terms, to a loan compared to what would be required by a traditional financial institution.

Future of Decentralized Finance

Decentralized finance is likely to become an increasingly important part of the financial system. It has the potential to unlock a significant amount of capital that is currently sitting outside of the system due to high barriers to entry. Defi encourages and also enables more people to participate in the financial system and discover new ways of generating value that simply isn’t possible in the existing centralized model. According to the recent survey of Fidelity Digital Assets 80% of the institutions are interested to invest in digital assets and the Chicago Defi Alliance -which includes many big investors -was created to support the growth of promising Defi startups. There are, however, significant challenges and obstacles in the way of realizing this vision. The most prominent among them is the need for sufficient liquidity and adoption.

Challenges:

Though Defi is facing different challenges varying from security hacks, fraudulent and scam vulnerabilities, high volatility in asset value, and challenges from regulatory authorities, etc. The computational cost for transaction settlement is called gas -for Ethereum blockchain- It’s also high for now but decreasing with the advancement of technology. However, its growth and acknowledgment of stablecoins by big countries like the US, China, India, etc. tells about its good prospects in the future. Moreover, with time, new innovations will make it more reliable, secure, and less risky.

Conclusion:

Decentralized finance is democratizing the future of finance. It is an evolving ecosystem that is challenging the status quo of centralized financial institutions. As a result, decentralized finance is unlocking a new source of capital, bringing transparency to the system, and empowering users to set their own terms. With the future looking brighter for decentralized finance, the industry will certainly be watching to see how it evolves to meet the demands of tomorrow’s financial system.