This article will explore the concept of Defi as well as create a comparison between traditionally centralized finance and the new age of decetralised finance.
TRADITIONAL FINANCE — HOW IT WORKS
The centralized authorities issue regular currency which further helps in driving the economy, and is used for different trades such as banks and government. Hence, the power of managing and controlling the supply and flow of these currencies is dependent on them.
Apart from this, all the control on our assets is passed to different financial firms such as banks, with the hope to earn higher revenues. The issue with all of this is that because the fund, as well as the control, is centralized, the risks are also higher.
This is where Defi comes into the picture! Defi (decentralized finance) has gained a great deal of prominence within the blockchain industry. Contrary to the decentralization of fiat money via Bitcoin, Defi aims to decentralize the traditional finance industry. The primary aim of Defi is to ensure that traditional financial services are available to one and all. Thus, Defi intends to provide a permissionless financial system, which is based on the blockchain infrastructure.
The provision of liquidity and token trading on decentralized exchange Uniswap which has 3 Billion in total liquidity have resulted in an explosion of innovation in decentralized finance (Defi). The ability to easily provide liquidity for new tokens has become instrumental for bootstrapping token networks in a world where centralized exchanges are no longer necessary.
HIGHLIGHTING THE ISSUES IN THE DEFI ECOSYSTEM
Defi, also referred to as Decentralized Finance includes protocols, digital assets, dApps, and smart contracts built atop a blockchain. Owing to the flexibility as well as the level of development, the ETH platform has become the main choice for the Decentralized Finance application.
The decentralized finance ecosystem comprises applications built atop publicly distributed ledgers, for facilitating permissionless financial services. Most decentralized finance tokens utilize incentivized liquidity farms (also referred to as yield farming) for maintaining a significant amount of liquidity. But this entails hyperinflation of digital token for making up for all the impermanent loss that liquidity providers endure. This, however, is unsustainable, and under the control of the digital token founders. This means the holders’ digital tokens are consistently being diluted as well as risk losing the purchasing power.
However, those who offer liquidity pose risk to investors since their behavior is not certain. As quickly as they can initiate a digital token’s market, they have the power to crush it down. This sudden liquidity removal also referred to as ‘rug-pull’, has become much common among the newly launched digital tokens.