Get to know DeFi or Decentralized Finance, a Blockchain-Based Financial Ecosystem
Cryptocurrency holders must be familiar with the term “decentralized”. The term “decentralized” itself means not centralized. This term is often encountered in the blockchain world because blockchain technology and cryptocurrencies often utilize a “decentralized” system in their information technology system. There are three decentralized systems that you need to know about, namely decentralized App (dApp), decentralized exchange (DEX), and decentralized finance (Defi).
In a previous article, Litedex discussed decentralized exchange (DEX). You can read about it in Know the Features in DEX, and Know the Differences between CEX and DEX. However, this time we will focus on discussing decentralized finance (Defi) in cryptocurrencies. Come on, see the following discussion!
What is Decentralized Finance (Defi)?
As the name suggests, decentralized finance is a decentralized financial system that operates without the help of a third party. Financial systems such as banks, stock securities, and financial brokers require a centralized system that is managed by the system. Unlike CeFi, activities within DeFi are processed automatically by the blockchain and can be used by everyone without any outside intervention. So, users can have direct control over their assets and freely interact with other users through a decentralized App (dApp).
All cryptocurrency assets can participate in the DeFi ecosystem as long as they use smart contracts. DeFi became popular in 2017 and grew rapidly in early 2020 until 2021. The total value of funds contained in DeFi smart contracts reached USD $1 billion in June 2020 and increased to USD $3 the following month. The total value of DeFi smart contracts continued to increase rapidly to USD $50 in the following year. Examples of DeFi applications are decentralized exchange (DEX), yearn finance, Kybe Network, RealT, and others.
Advantages of the De-Fi Ecosystem
Transparent System
In general, blockchain uses a decentralized financial system. All activities and transactions recorded on the blockchain will be recorded by a ledger. This is what makes blockchain an advantage at a transparent system level. The proof-of-work algorithm adapted by the Defi blockchain cannot be manipulated because the data stored in the algorithm is immutable.
Active 24 Hours
Unlike centralized financial systems, DeFi has no time constraints in its ecosystem. In contrast to centralized financial systems such as banks, which often go offline when the system is under maintenance, the DeFi system is active 24 hours a day. You can transact on DeFi anywhere and anytime. The system is active for a full 24 hours making the entire verification process in DeFi run faster and easier.
Accessibility
The DeFi ecosystem can be accessed by anyone without exception.
User Authority
Do you remember the case of the state-owned insurance company Jiwasraya that swallowed customer money with a total state loss of Rp. 16.8 trillion? Or the case of Century bank with a total state loss of Rp. 689.39 billion and Rp. 6.76 trillion in 2009? Several cases of money laundering and lost assets often occur in centralized financial systems. In the DeFi financial ecosystem, you don’t have to worry about your money being lost or corrupted by any party. The assets stored in DeFi are completely under the control of the user. In addition, DeFi also has no control over user asset management such as banks and other centralized financial systems. For example, DeFi cannot pledge user assets as collateral, lend user assets to other users, or take profit (profit) from assets stored in DeFi.
Weaknesses of DeFi
Risk of Attack by Hackers
Just because a DeFi system has advantages that centralized finance doesn’t have, it doesn’t mean that DeFi is without threats. Hackers or hackers are a major threat in the DeFi ecosystem. DeFi has the potential to be hacked, whether in the form of theft of funds or user data. However, the potential for hacking depends on the security level of the software system used by DeFi.
Private Key
You must be familiar with the private key in your crypto wallet. If you don’t know what a private key is, the private key is a code to activate the encryption and decryption algorithm of text in a crypto wallet. In the DeFi and cryptocurrency ecosystems, you have to secure the wallet or wallet where you store the crypto assets used with a private key. In short, the private key is a long and unique code in the form of a phrase (random sentence) that is only known by the wallet owner. If you lose the private key, you will lose access to your wallet. You have to be very careful in storing the private key because there is no way to recover a lost private key.
High Credit Guarantee
Not only banks and online collateral companies, DeFi also has loan facilities as creditors to its users. The collateral or credit value submitted by the user is used as collateral for the credit. However, almost all collateral products in DeFi require a guarantee of at least 100% of the loan value. This requirement is certainly very burdensome for related debtors and limits users who meet the requirements in applying for various loan products in DeFi. An example in the conventional financial system is mortgage collateral. When you get approval in the mortgage application process, the mortgage loan must have collateral, namely the house you bought with the mortgage credit system.
No Consumer Protection
The DeFi ecosystem does not yet have rules and regulations regarding the use of DeFi. In a centralized financial system, for example, the Federal Deposit Insurance Corp (FDIC) provides deposit reimbursements to customers of up to $250,000 per customer or per institution if the bank goes bankrupt. Banks are also required to have reserve capital to maintain the stability of their assets as a form of collateral for customer assets whenever needed. For DeFi, unfortunately, there is no similar protection.
Low Liquidity DeFi
The low liquidity in DeFi could be a factor in the low adaptability of DeFi technology. In October 2020, for example, the total value of assets in a DeFi project was more than $12.5 billion. This figure is still relatively small in the conventional financial system. The limited liquidity in the DeFi ecosystem makes people not fully trust the DeFi business ecosystem.
DeFi Scalability Level
The limited scalability of hosts on the blockchain is also a factor in DeFi’s weakness. The level of scalability on a blockchain can affect the speed at which a transaction is confirmed. The Ethereum blockchain, for example, can process 13 transactions per second at full capacity. If you don’t know what scalability is, you can read about it in Understanding New Trends in Blockchain Technology.
That’s a basic explanation of what decentralized finance (DeFi) is and the advantages and disadvantages of the DeFi ecosystem. Don’t forget to share and comment in the comments column, okay? Continue to follow our articles so that you understand more about knowledge in cryptocurrencies. Don’t forget to visit the Litedex website, Instagram, Twitter, YouTube and TikTok to keep getting updated information from us.
