Blockchain is here to stay. Banks are currently being challenged by the formation of a new Decentralized financial ecosystem ten years after the launch of bitcoin.
The term “bitcoin” originally entered the mainstream in the early 2010s, when the media began to talk about cryptocurrencies. And right about now, faced with a surge in this ever-growing plethora of digital assets, central banks have begun testing central bank digital currencies.
This current transition shows a level of acceptance of the influence of cryptocurrency that helps explain, in part, the formation of a Decentralized finance ecosystem, often known as DeFi, which will be discussed in this article and how it brings about a revolution in traditional banking.
What Is Decentralized Finance?
Decentralized Finance, or DeFi, is a mechanism for making financial products available on a Decentralized blockchain network open to the public. We’re accustomed to everything passing through a bank or other financial organizations, such as a global exchange, but DeFi establishes an autonomous system. As a result, anyone can utilize them instead of going via intermediaries like traditional banks or brokerages.
Unlike a traditional bank, Decentralized finance systems do not require a government-issued ID, Social Security Number (SSN), proof of address, and other stringent banking requirements like receipts of bills payments.
Decentralized Finance also refers to a system in which buyers, sellers, lenders, and borrowers connect peer-to-peer or with a strictly software-based intermediary rather than a firm or organization conducting a transaction using software developed on blockchains.
How Does It Work?
Decentralized Finance, rather than a traditional bank, employs technology to facilitate transactions and services between parties. Along with public blockchains, several open-source protocols are being created, establishing a framework for Decentralized Finance to function on.
A finance system requires two main components to function: an infrastructure and a currency. Banks and financial institutions serve as the infrastructure under a centralized system, while fiat money, such as the US dollar, serves as the currency. To provide a comprehensive range of financial services, Decentralized Finance must replace these components.
Differences between Decentralized Finance and Traditional Banking System
Decentralized Finance (DeFi), as the name implies, extends the decentralization idea found in cryptocurrencies to the whole financial industry at large.
By default, traditional banks act as custodians of money and facilitate numerous transactions on behalf of their clients. Credit, loans, and insurance, for example, are all centralized banking services. Partners and intermediaries must be compensated and have access to these services, and one must obtain the necessary qualifications and commit time.
Decentralized financing reduces the need for mediators and, depending on the product, allows for very competitive returns. DeFi’s goal is to provide direct financial access to everyone, as everyone can gain access without the need for an account, and everything is unrestricted.
And given that DeFi is a public blockchain, and by its very nature, it provides transparency and empowers people over their data, some customers are more inclined to abandon the present system, which gives them less power. DeFi offers a compelling alternative to banks by increasing access and providing both traditional and new services.
The plethora of differences between Decentralized Finance (DeFi) and Traditional Banks can be summarized thus:
- Under a DeFi system, the user keeps their own money, while under the traditional banking system, money custody is through banking intermediaries.
- Units of DeFi are digital assets, while units of traditional banks are mainly fiat money.
- Movement of funds and execution of services are being done through smart contracts, which take only a matter of seconds, while that of banks is being done by the banks, which takes several days to execute.
- DeFi is made available at all times of the day, while traditional banking services are permanently restricted to working hours only.
- DeFi is governed and managed by developers and users, while traditional banks are controlled by stock exchange and regulators.
Why Decentralized Finance Will Revolutionize Banking?
Decentralized Finance (DeFi) would revolutionize traditional banking given these advantages. On DeFi, everyone has access to financial services from any place, with its 24/7 availability, and given that due to the absence of mediators, expenses are reduced. Returns are high, and complete transparency is provided for all transactions on the blockchain, and human mistakes are reduced due to process automation.
Traditional banking is being updated as we write this to match up to the expectations of the future to tap into the new financial services innovation in several ways, which include:
Issuance Of New Financial Innovations
A business called Coinbase pioneered the use of DeFi in conjunction with the traditional financial system. Conventional fiat currencies (USD and EUR) can be traded on this platform. In the first half of 2020, Coinbase’s profits skyrocketed due to the continued mass use of cryptocurrencies.
Coinbase could serve as a model for established financial institutions to expand their offerings in this new economic system. Customers who are both tech-savvy and risk-averse are driving demand. There is a lot of opportunities for private investors in the future. A growing number of these people have already set up a crypto test account with small sums of money and are interested in cryptocurrencies.
Similarly, there is a lot of interest from regulators and central banks in the subject of cryptocurrencies. To keep up with the latest advancements in each country’s Central Bank Digital Currency (CBDC), in France, China, and Canada, advanced pilot testing is taking place as we write this.
Through this new technology, established banks can influence the development of future regulations. Banks, DeFi providers, and regulators could work together in this endeavor. So, they can “co-create” new creative offerings and contribute to establishing the regulations that govern them.
Today’s total value of all cryptocurrencies stands at a mind-boggling $2.02 Trillion (as of November 3 2021). As of this writing, Bitcoin has a market value of more than $1.17 Trillion. It’s not surprising, given it’s now possible to buy Bitcoins through various exchanges and even ETFs.
Many clients are looking for a safe place to save their crypto assets and trade them. Most banks are unable to meet this demand from their customers.
The reasons behind the reluctance include currency volatility, lack of expertise, and ambiguous regulatory requirements. BBVA and SEBA in Switzerland are examples of early adopters. Trading and custody of Bitcoin and other digital assets are also available through BBVA Switzerland.
Decentralized Finance, protected by blockchain technology, reduces the danger of fraud, corruption, and mismanagement of your assets. It will also make managing finances significantly more cost-effective and efficient. With Decentralized Finance, overdraft fees, among other things, will be a thing of the past.
Money transfer is only one part of the existing centralized financial system; however, Decentralized Finance aims to replace all aspects of the system, including exchanges, loans, insurance, and savings accounts, leaving traditional banks no options other than to join the train.
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