How Is DeFi Changing the Financial Markets?

4 Mins read
  • What is DeFi, and how to make money on it?
  • How is the DeFi sector changing the global financial structure?
  • How is crypto processing changing the payments sector, and why?

Everywhere you look, there is this hype about Bitcoin, Ethereum, Ripple, and other cryptocurrencies. You can see tons and tons of crypto articles, videos, social media posts, and memes; crypto is everywhere.

But something is boiling up beneath this magma of BTC, ETH, and others. It is DeFi. Ever heard of it before? Some of you might have heard about decentralized finance or DeFi before; however, most people don’t realize its significance in the financial markets.

In this guide, we’ll present you with an overall picture of what DeFi is, its purpose, and how it is changing the course of financial markets.

DeFi explained

To understand DeFi, you need to know a few concepts:

  • It is a process by which you can acquire financial products without the need of a middleman.
  • The way it works is these products are publicly traded on the blockchain network. So you go in, get out, and that’s it.
  • When you deal with a broker or a crypto exchange, you need to go through a specific process. It would help if you had ID verification, proof of address, and other credentials.
  • With DeFi, there are peer-to-peer transactions. Blockchain jot down all the info, and sellers/buyers and lenders/borrowers can make a deal themselves rather than relying on a broker or a bank.

How are you going to trade without the involvement of an intermediary? 

Decentralization happens because of particular protocols and technologies. Thus, a decentralized transaction can comprise multiple protocols or sources of technologies, and a buyer/seller signs a contract with each other. But this isn’t your typical contract. It’s a smart contract.

A smart contract writes the terms and conditions of buyers and sellers in the form of code. This code is self-executing, meaning you don’t have to grab a pen and write it yourself. Instead, a code will do all the work for you.

What makes DeFi special?

Yes, tech is everywhere, and the modern financial ecosystem relies on it. However, the role of banks or brokers is facilitation. They facilitate you in making a transaction.

For your transactions to happen, they compete with their counterparts, go through several legislative procedures, and contest with financial markets. On the other hand, DeFi uses the blockchain that focuses on the nitty-gritty of technology. 

So you understand what DeFi is and how it works. Let’s pack a bag and go into the wilderness. Wait, before you go, do you not want to know the factors that led to the creation of DeFi.

The creation of DeFi

DeFi logo

The formation of DeFi is an exciting story, as it defines how the global financial system works and its loopholes.

The current financial ecology worked on the hub and spoke model. The model is an investment vehicle where multiple investment vehicles combine their assets to form one large vehicle.

The critical global economic centers like New York, London, Tokyo operate as investment vehicles through which multiple vehicles get their power. These centers like Amsterdam or Paris may not be large vehicles, but they are the primary vehicle in their economies.

The economic blood flow starts from the key players like New York and London then trickles down to smaller players like Amsterdam. A sort of like a domino effect.

What does it mean? 

Let’s say New York is facing some trouble as the US economy is in trouble. This will trickle down to Amsterdam and other small players. This is what happened in the 2008 financial crisis.

The hub and spoke model is based on interdependence. Big players have a significant reach worldwide and have their investment interests, and they are subject to regulations and procedures. Their broader spectrum has made them the manipulator of the global economy.

In the 20th century, especially after the Second World War, the economic model produced fruitful global economies. However, this manipulative nature of the big players caused a global recession in the 1930s and the financial crisis of 2008. This manipulation led to the development of a new financial system.

Along comes DeFi to the rescue. The decentralized financial system employs tech to cut the manipulation of key players. DeFi’s apps and services have a blockchain, which means you can build the same technology or build your own using custom tweaking.

Moreover, DeFi users have more control over their money. Each user has a personal wallet, and no one can manipulate it. For DeFi to work, it only requires currencies. Currently, DeFi works on crypto and lending services.

What are smart contracts?

They code the infrastructure you need to run DeFi apps and services. Let’s define this with an example. Say you want to sell the BTC at 36506 against the USD. On the other side, someone else is willing to buy at that price.

BTC/USD_4h_ chart

A smart contract will code all your and the buyer’s terms and conditions. If the buyer doesn’t follow the terms, a smart contract will liquidate the terms, and you won’t lose any money.  

The present and the future of DeFi

According to one estimate, there are $41 billion of DeFi contracts. Of course, you must be thinking we are kidding. But this is how it is.

Although this number looks significant to you, it is critical to note that DeFi lacks liquidity and volume for trading cryptocurrencies. Besides, DeFi has its issues like hacking and technical flaws. Hackers can take the users’ funds by breaching DeFi’s protocols.

There is a constant debate that the deregulated nature of DeFi can pose severe problems to global regulations. Who can you point fingers to, as there are borderless dealings? Who will be responsible for software mishaps?

These are the questions surrounding the debate.

Final thoughts

Although there are a few hiccups, DeFi is the rising sun of the financial ecosystem. It is sure to impact the financial system in the upcoming years. There are a few challenges but no significant drawbacks.

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