Finance is a crucial part of the global economy and plays a significant role in people’s lives.
Decentralized Finance, commonly known as “DeFi,” is the term used to describe a blockchain-based financial services system that eliminates the need for government agencies to approve transactions.
In other words, normally, if you want to take out a loan, you have to go to traditional banking institutions. DeFi aims to change that. It functions as a blockchain-based financial entity or banking system where you can operate with digital assets or cryptocurrencies without transaction costs imposed by institutions like central banks.
However, if you’re considering using this method of financing, there are several points you should take into account.
Having a professional who can advise you is crucial, especially if you’re dealing with these topics for the first time. One of the most reliable options is Evans Sternau, a global network of committed CPAs and accountants that focuses on providing customer service strategies and resolving industry challenges.
Now, let’s delve a little deeper into the topic. How does DeFi work?
DeFi utilizes a blockchain-based ecosystem to bypass traditional financial service systems or “intermediaries.” They employ digital wallets, smart contracts, digital agreements, and oracles.
As a decentralized system, DeFi possesses a financial infrastructure that operates on multiple computer networks, serving as public ledgers that store digital copies of transactions. They use cryptocurrencies and smart contracts or digital agreements.
Therefore, we can understand DeFi as a collection of online financial applications and platforms seeking to create a more transparent, secure financial system that allows operations and transactions without intermediaries.
Strengths and Weaknesses of DeFi
Financial Freedom: Decentralized finance disrupts the notion of a singular financial system, such as traditional banking institutions. Many view these new technologies as liberating alternatives that are more transparent and faster.
Universal Access: Anyone with a mobile device or PC can access the DeFi network from anywhere in the world. Moreover, unbanked individuals can also access these technologies. This benefit provides a competitive edge over traditional financial systems.
Security: Powerful cryptographic techniques are employed to ensure that the platform, accessibility, and usage are controlled by authorized individuals. It provides a tool for executing various economic operations securely, directly, quickly, and in a decentralized manner.
Transparency: This technology is built on open-source software, making every line of code auditable. Access to this type of platform is borderless, allowing anyone to access its services regardless of location.
Permissionless: Trading on the network is not required to access DeFi technologies. This functionality is integrated thanks to the blockchains of the DeFi system.
International Financing: International financing of companies and products is much simpler due to DeFi protocols. They cater to the needs of a target audience to facilitate development and investments wherever needed.
Access to national tax advisory services will be crucial to understanding the method we are adopting and how it will impact our company.
Decentralization Risk: Decentralization can be a weakness if not managed correctly. Many consider a somewhat centralized financial system necessary, as it can be a strength during economic crises.
Price Volatility: DeFi does not have complete control over price volatility. Often, this is beyond their control, as cryptocurrencies are not very stable assets, posing a risk within decentralized finance. Mechanisms to control this fluctuation are often insufficient.
Enhanced Security Needed: While DeFi technologies are more secure, they are not entirely so. The level of security must still be improved, particularly when it comes to aspects as critical as smart contracts.
Being such a recent and new financial system, these weaknesses are gradually being addressed, causing many to hesitate when integrating.
What’s the Difference Between DeFi and Cryptocurrencies?
Although cryptocurrencies are decentralized, they are not DeFi, and vice versa. There are some differences between DeFi and cryptocurrencies. The value of cryptocurrencies like Bitcoin is stored within their blockchain. In contrast, DeFi is a conceptual market offering various cryptocurrencies on the Ethereum network.
With DeFi, cryptocurrency holders can lend their digital coins and earn interest on them. Another option is taking out loans based on the cryptocurrencies held in their digital wallets.
In summary, DeFi is a blockchain-based financial services system that circumvents government agencies and the current costs associated with traditional banking or investment entities.
It’s a new option aimed at assisting those who want to invest in their businesses and cannot or do not wish to deal with banking institutions. Although certain security aspects still need assurance, DeFi is making steady progress in becoming a better option for those seeking alternatives.