Published on September 9th, 2020 | by Bibhuranjan

What is Decentralised Finance Tech & How Will Shape the Financial Industry?

Decentralised finance is a way to get loans or make other financial deals using decentralised apps to organise the transaction. Two people can make a deal without needing to use a bank or intermediary financial institution. The concept right now is known as DeFi and this could be the next big global technological change to the way we manage our money.

Traditional Financial Apps

At this time, we use financial apps to manage our everyday banking. These apps are connected to our bank who manages our finances centrally. Banks have huge reserves, and these are made up of our money which is what is known in the banking world as ‘customer accounts’.

If you have ever heard of Nick Leeson, the reason he went to prison is that he lost a lot of money trading using the banks risk finance packages made up of people’s money invested into the bank. He then decided to dop into the customer accounts to try and recover his losses, but this backfired and the bank went under and so did people’s savings.

Their savings were supposed to be safeguarded by the bank and not used for any risk trading. In short, when you use a bank, you are putting your faith in their ability to safeguard your money. You gain interest on your savings which is usually covered by people’s loan and other credit interest as well as the bank’s successful trading endeavours on stock exchanges such as FTSE and NASDAQ.

To interact with you bank, you have your banking app. If you need a loan, you are tied into negotiating with the bank, if you want finance on a car, then the same rule applies. You can also go outside of your bank to other financial companies and apply for credit or finance if you so wish. All that is needed is two apps to manage your finances, and these apps are connected to the banks’ IT systems.

DeFi Financial Apps

With decentralised finance, you keep your money inside a digital asset. These are digital gadgets that help us manage loans and other financial aspects of our lives.

Today most people use USDT to peg the value of their digital assets against. This is because this digital token is tied to the US$ which is considerably more stable than using any of the more volatile digital currencies that could fluctuate at any time. Some people like to mix it up and use both.

They save some money inside a volatile digital currency which could appreciate tremendously and then keep their other cash inside a more table virtual currency like USDT. In the end, this gives the person decentralised financial savings that are not tied to a bank.

If someone is on the same DeFi ecosystem using the same dapp, then they can strike up a deal between each other for securities, loans, finance, or trades. They can create a smart contract between themselves with no lawyers or intermediaries charging a percentage.

For example, someone may want to get to a loan and another person wants to earn interest on their digital assets. Both people on the same dapp can negotiate a deal. Most of the time people will need to have digital assets as collateral to make the loan happen which is slightly different to banks who can give you a loan without any collateral needed.

There are many other uses for DeFi ecosystems and dapps. These could be trading prediction algorithms using artificial intelligence, insurance deals such as medical or home insurance, saving plans could be given using DeFi, and even home mortgages, as well as sales, could end up all becoming part of every day open finance.

How Do You Know Your Loans and Money Are Not at Risk?

Most banks are a safe bet when it comes to having someone manage your money for you. With DeFi, you are putting your trust into the ecosystem that you choose to use. However, this is the beauty of it because these DeFi ecosystems are built on open source technology that is transparent so you can see a smart contract in progress without knowing who the owner is.

Every one of these contracts is governed by the ecosystem’s rules and there is no one owner. Both people in the deal own it and if terms need to be changed, then both parties will need to agree. If one person does not agree on the changes, then there is absolutely no way it can be changed, and the original terms will stand.

The only way for a smart contract to close is for the terms to be met. For instance, in the case of a loan, there are milestones in place. These would be payment milestones. Each time a payment is made to the smart contract, the milestone is satisfied until all milestones are complete at which point the loan has been paid off and the smart contract will close.

Now just because the smart contract closed does not mean it will disappear never to be seen again. It will be an immutable record now part of the ecosystem it was created on. You can always see it even though it is not active, and you can always see what the terms were without ever knowing who the people involved in creating the contract are because the entire system is anonymous.

Photo by M. B. M. on Unsplash

Tags: banking, finance, financial decentralization, FinTech, security

About the Author

Bibhuranjan Editorial Officer, technofaq.org I'm an avid tech enthusiast at heart. I like to mug up on new and exciting developments on science and tech and have a deep love for PC gaming. Other hobbies include writing blog posts, music and DIY projects.