Decentralized finance or Challenge is a finance based on decentralized exchanges. It eliminates the need for a central bank or the government to approve a financial transaction. The Challenge relies on blockchain and smart contracts to automate exchanges and ensure that no one entity has control.
What makes DeFi different from traditional finance?
To understand what is Challenge, it is necessary to keep in mind the functioning of centralized finance. Centralized finance is controlled by a central authority. In our case, the management of the currency is carried out by the government and the banks. For example, the government can print more banknotes if it wishes and it is up to the bank to approve a loan. A central authority logically limits what you can do with your money.
On the other hand, the Challenge is based on blockchain, i.e. decentralized networks. It runs on computer code called smart contract. The code is open to all, it is possible to scrutinize it if desired. Once programmed, a smart contract triggers itself. Exchanges are made using decentralized applications or Dapps. Since the objective is to give control back to users, one can easily transfer money, become a liquidity provider or a lender.
How does a smart contract work?
Apart from the automatic part, a smart contract is similar to a classic contract. First, the stakeholders determine the terms of the contract, which here are translated into code. Once the code is created, it is stored in the blockchain and replicated for each participant. When the conditions are satisfied, the latter check if it is ok and the contract is validated. However, it should be noted that a smart contract is not yet legally recognized.
Types of Decentralized Exchanges
Decentralized exchanges (DEX) have diversified rapidly in recent years. Services similar to traditional banks are now available:
- Loans and borrowings: borrowing and lending platforms based on the blockchain (borrowing and lending) have quickly emerged. The smart contract is used to approve transactions and fulfill the terms of an agreement.
- instant loans or flash loans: these are loans without counterparty risk. It is not necessary to give a guarantee. On the other hand, there is a mandatory condition, to be reimbursed in a single transaction.
- Staking: Staking is the act of immobilizing your crypto-currencies in a smart contract so as to be able to participate in the operations that take place on a blockchain. Unlike mining, you store your crypto in order to benefit from advantages.
The benefits of DeFi
The Challenge has several advantages, the main ones being the absence of intermediaries and the reduction of transaction costs. Indeed, traditional finance is expensive compared to decentralized finance. It is also slower. Another advantage is the reduction of the margin of error, the operations being managed by a machine.
Each transaction is transparent and instantaneous. This ensures the security of the exchanges, moreover the smart contracts serve as a guarantee against fraud and scams. Since a smart contract is immutable, all conditions set in advance must be met for the operation to be executed. In the event of non-compliance, the contract expires. Another strong point is the anonymity of the users. During a decentralized exchange, only one address is used. It is not possible to see the personal information of the speakers.
The disadvantages of DeFi
Decentralized finance still has its drawbacks. The most obvious is its dependence on computer code, you are never safe from a bug. The best is to use the Dapps in stable version for years and updated regularly. The opinion of users is also important, do not hesitate to ask on forums.
Another disadvantage of the Challenge, the user manages the risks alone, because there is no entity that covers him. This is why decentralized finance has a hard time convincing the general public. Especially since the Dapps are difficult to use, as most have a non-smooth interface. You can get lost quickly, and a beginner is quick to move on.