The working of Decentralized finance draws inspiration from Bitcoin's blockchain technology, in which a decentralized public ledger of blockchain stores transaction details in codes. All the transactions in a DeFi are controlled by smart contracts, and these smart contracts are available for everyone to read and understand. Any activity on DeFi takes place only if it meets the conditions stated in the smart contract. Since these smart contracts are unchangeable, there is no chance of fraud and alterations in the whole DeFi system.
Let's understand through an example how the smart contracts of DeFi secure its transactions.
Assume that a smart contract is developed to transfer money from Account A to Account B on a specific date every month. Now, no bad actor can alter this process and execute fraud by sending money to a new address called Account C. This is because the smart contract is immutable and can not be changed once deployed. That means no fraud can take place by changing the smart contract protocols.
These blockchain-based smart contracts can save lots of time and cost because people transfer assets directly with one another on Decentralized finance. On the other hand, intermediaries, like banks, add an extra step to send or receive money in the traditional financial system.
What is the connection between DeFi and Bitcoin?
DeFi and Bitcoin share the same base to a very extent. Both are based on a decentralized, immutable, public ledger to record their transactions. Bitcoin is so valuable in the crypto market because of its strong technology. Many crypto institutions use this technology as an inspiration. Even though the thought process and backend functioning of both Decentralized finance and Bitcoin is the same, there is a big difference between them.
A bitcoin is a cryptocurrency, whereas DeFi is an ecosystem that is programmed to have multiple operations performing through bitcoin or other cryptocurrencies.
Who manages the Decentralized finance platforms?
There is no middle man required in decentralized finance platforms to manage the system. Smart contracts manage everything. All the decisions of a DeFi take place according to the digitally developed protocols of its smart contract. This eliminates the need for any human intervention in managing a DeFi.
Let's take the example of a loan to understand the automation of DeFi.
If you go to any traditional bank, there would be loan applications, paperwork, approvals, and many verifications involved. This is a time-consuming process involving several middlemen to perform various verification processes. Also, the bank will have the sole right to accept or reject your loan application.
But if you want a loan through a DeFi, you only have to enter your loan needs in the decentralized finance platform. Once you enter all the details of your loan requirement, the rest of the work will be completed through the smart contracts or protocols on which DeFi works.
The DeFi will use its algorithm to find suitable peer matches (lenders) who are interested in lending you a loan. Here, the DeFi only acts as a common platform for lenders and borrowers instead of the lender itself. Once DeFi finds a suitable lender, it will share the terms and conditions of that lender with you. If you agree with those conditions, you will receive your loan and the transaction will be recorded in the DeFi blockchain.
This is how smart contracts manage the complete process of a loan without intermediaries.
What are the applications of Decentralized finance?
With the soaring popularity of decentralized digital assets, it is clear that the world strongly believes in decentralization. Moreover, the flaws in traditional finance institutions are more than ever. A clear need for something more advanced and direct is inevitable.
The transfer of assets and other banking functions are already happening on DeFi. Storing money in crypto wallets, trading cryptocurrencies, and tokenized investments anytime, funds and non-fungible tokens (NFTs) are other use cases of the decentralized finance platforms in the crypto world. Also, with the coming of more dapps in the market, the utilization of Decentralized finance platforms can reach new heights soon.
