Since the late 2000s, when the blockchain era began, numerous firms have been looking for ways to use the technology in some way. Following the emergence of cryptocurrencies, the financial sector jumped on board, looking for better methods to use blockchains. Long after that, the innovative notion of Defi, also known as Decentralized Finance, emerged - an idea that promises to be the banking sector for cryptos, but without the need for any intermediaries.
In this article, we'll take a closer look at what Defi is, how it works, and some of the most popular Defi platforms available today.
As previously stated, decentralized finance (Defi) is a new-age financial system based on blockchain technology that operates without the use of intermediaries. Although the blockchain that hosts the Defi system replaces the role of the central authority, it functions as a peer-to-peer transaction system. The concept seeks to provide users with a transparent, open, quick, and permissionless transaction experience.
Smart contracts are fully exploited here because they can upgrade themselves depending on the received data without the need for third-party intervention.
There are two sorts of Defi transactions: Defi lending and Defi borrowing. Let's take a closer look at them.
Lending and borrowing take place as true peer-to-peer (P2P) transactions in the Defi environment. Crypto loans are available without the involvement of a third-party authority in this case. Cryptocurrency owners can also lend their coins through these sites, with the interest produced serving as a source of passive income. Borrowers can take loans directly from P2P lending services that operate on Defi principles.
1. A borrower must first register an account on the Defi lending platform and link their cryptocurrency wallet to it.
2. The borrower must then hold some crypto assets as collateral to obtain a loan in fiat money, which is frequently greater than the loan value due to the volatile nature of cryptocurrencies.
3. When the borrower has paid back the loan amount plus interest, the borrower's crypto collateral is returned.
4. Because the borrower pays back the loan with interest, the money travels directly to the lender, who can profit from the arrangement.
When the borrower has paid back the loan amount plus interest, the borrower's crypto collateral is returned.
5. This can even happen in a role-reversal scenario, where a lender lends cryptos in exchange for fiat money and subsequently earns interest as a passive source of income.
6. This is necessary since cryptocurrency sitting idle in a wallet will not generate any passive income. According to the existing scenario, the speculative concept that its exchange rate would rise in the future is pointless.
7. But why is it necessary for the collateral to be greater than the loan amount? Because the present cryptocurrency market is volatile, a one-to-one collateral value may be rendered useless if the collateral value falls below the lent amount. Defi platforms devised a solution to address the problem.
1. Because everything is written on smart contracts, there is no central authority handling Defi loans.
2. Defi platforms typically give borrowers lower interest rates, relieving them of the burden of a large repayment. For different cryptocurrencies, different portals charge varying interest rates.
3. Lenders can benefit from these platforms since their deposits earn them a greater interest rate.
4. Some sites can offer "Flash loans," which are loans that can be obtained instantly, but must be repaid within a certain amount of time or the transaction will be annulled. The borrower, for example, must repay the loan amount plus a charge within the block cycle of the blockchain on which the smart contract is based, or the smart contract will not change, essentially cancelling the loan.
5. Users can also vary interest rates between stable and variable to shield themselves from the consequences of cryptocurrency volatility behaviour.
6. Some of the most popular Defi platforms do not have any loan or borrowing limits in their portals.
1. Due to their cloud-based structure, Defi lending platforms generally offer faster loan processing times, analytics for fraud detection, and machine learning for optimum loan terms and risk factors.
2. Because the processes are digitally supported, there are no differences in analyzing application attributes, and each applicant is examined according to established credit criteria.
3. The Defi lender can ensure compliance with local requirements by using decision rules that play evidence for each loan transaction.
4. Lenders and borrowers can learn critical information about the present loan environment by using analytic data gathered through Defi lending websites. Lenders can know the seasonal loan demand and distribute cash to the pool if the user monitors the analytical data for a week. Lenders can also obtain information on their borrowers' demographics and credit levels, while borrowers can gain a thorough understanding of the lending sources. Users can then work on improving their portfolios before the next transaction.
5. As previously said, Defi lending is permissionless and truly peer-to-peer, which eliminates geographic location and minimum fund requirements.
6. The procedure is completely transparent, and analytic data further enhances the platform, thanks to the Defi platform's public blockchain, which displays every transaction and requires every user to validate it.
7. Information on a Defi lending portal, like any other blockchain-based product, cannot be tampered with, boosting the level of safety and trust in such platforms.
8. Smart contracts' programmability ensures that process executions are automated and that new digital financial instruments are created.
9. Defi lending platforms can ensure that their protocols and regulations complement each other efficiently by using an interconnected software stack.
10. Because Web3 wallets (such as Metamask) are used, Defi platform users may rest assured that their data is under their control and not under the control of a third party.
If you've made it this far through the blog and have decided to enter into the Defi lending platform business as a lender, borrower, or platform owner, you can do so without hesitation. However, make sure you are aware of any applicable legislation and how your local laws view such platforms.
Hiring Infograins Software Solutions as your developer will help you turn your vision into a reality if you're an entrepreneur looking to launch a new Defi lending platform. Get in touch with one of our specialists right now to start realizing your idea.