Since Bitcoin was first presented to the world in 2009, many developers and tech-savvy investors have seen in its underlying technology – the blockchain – the kind of potential that few other technologies have exhibited in history.
There are many aspects of this revolutionary technology that can change the way the world works including decentralization, widely-accepted consensus mechanisms, fair compensation, strong security, and high network uptime.
One particular industry that can be entirely transformed by this ground-breaking system is finance, as blockchain can remove the middle man from most of the transactions that are processed by today’s centralized institutions to offer consumers a cheaper, more objective, and possibly faster alternative to get a loan, operate in the financial markets, and save money.
In this article, we discuss how decentralized finance – also known as DeFi – works and how it can reshape the financial industry once and if consumers start to get more familiar with its incredible advantages. For more information about DeFi and its intricacies, readers can also visit defipedia.com.
Smart contracts and their crucial role in DeFi
Smart contracts were designed to take advantage of decentralization and consensus to automate certain transactions that take place within the blockchain ecosystem.
Simply put, a smart contract is a piece of code that prompts a certain action whenever a handful of parameters have been fulfilled.
These instructions are stored within the blockchain and they are executed no matter what as decentralization ensures that no one can alter or prevent the execution of a contract while it is active.
Smart contracts remove the need for an intermediary as no one has to guarantee that certain transactions will occur. In this scenario, the blockchain will act as the executioner.
By using advanced smart contracts, a blockchain could take over the role that financial institutions have in analyzing and approving loan applications and other similar transactions.
The same goes for a broker that needs to process a certain operation on behalf of an investor such as buying or selling a stock. Instead, the customer could interact directly with a decentralized exchange.
The power of decentralization
What is decentralization exactly? Simply put, a blockchain is a ledger where transactions are recorded as they come. These transactions are added to a database that is stored by many different nodes – these are computers that actively validate all new records to keep the network safe and free from being corrupted.
The copies stored by all nodes must be exactly the same at all times and every time a new record is added all nodes will be notified and their version of the code will be updated accordingly.
Since everybody will share the same copy at all times, if a node tries to introduce an altered copy that contains different data, the network will automatically exclude that node from participating.
Decentralization is considered one of the pillars of blockchain technology as it ensures elevated network up-time, transparency, and fast transaction execution times.
Lower costs, faster execution, and more objective criteria
Now, how can blockchain technology benefit consumers and revolutionize the financial industry?
We can break down the answer into the different processes that take place whenever a customer interacts with a financial institution.
The first step is to open an account with a provider. In most cases, this process involves submitting certain documentation to the institution and waiting until the account is approved.
Blockchain technology would only require that users open a crypto wallet and deposit their funds within it to participate in the decentralized financial industry. This would reduce privacy concerns and would facilitate access to all the products available within the ecosystem.
The next step is to apply for one of the most common products offered by the financial industry – a loan.
Secured loans could be easily extended to consumers through the blockchain as their assets will also be stored within the network. These assets can be locked and released as needed through the use of a smart contract and interest payments can be deducted directly from the borrower’s wallet to compensate the lender.
Moreover, if the value of the collateral declines, the loan could be immediately repaid to guarantee that the lender will not suffer a loss.
Even though decentralized finance is still in the earliest stages of its development, it is already obvious that the underlying technology that powers it can change the way the financial industry works in many ways.
The removal of the middle man in all financial transactions will likely benefit consumers directly and could facilitate access to certain products and services that have been controlled by institutions whose interests are not necessarily aligned with those of the clients they allegedly serve.