Finance is the lifeblood of any economy–both traditional and crypto-based. On the one hand, financial institutions make up the majority of financial market players in the real world; on the other, DeFi applications are burgeoning in the crypto world. In today’s TRON 101, let’s talk about DeFi and its advantages against traditional finance.
The acronym “DeFi” stands for decentralized finance. It has three essential parts: cryptography, blockchain, and smart contracts. Like traditional finance, DeFi is also dedicated to providing financial services such as lending, trading, and insurance, except that it does not depend on centralized institutions.
Take lending as an example. Before there were banks, lending money from strangers had been unthinkable, and most people borrowed money from people they knew. Then emerged traditional banks, which act as the middleman and build a bridge of trust between borrowers and lenders. With more people lending money from strangers, the liquidity of assets is improved substantially.
However, the lending service that banks provide is inconvenient and costly. To access the service, borrowers need to provide information such as ID, proof of income, and credit score for a rigorous bank review. The lending rate provided by banks usually ranges between 5%-20%. And sometimes, borrowers need to afford extra service fees charged by vendors. In comparison, DeFi lending is more efficient and affordable. It is based on a peer-to-peer model: users deposit a certain amount of crypto assets as collateral when borrowing, and their asset is guaranteed by a smart contract instead of a middleman.
In addition, people lack trust in traditional centralized financial institutions–the misconduct of centralized financial institutions is hardly new. DeFi, on the other hand, relies on smart contracts to provide financial services. The terms of DeFi services are all written in code, and no one can tamper with them on their own. People do not have to trust each other, as code does all the work.
Another advantage of DeFi against traditional finance is its capacity to combine multiple applications and protocols for the purpose of creating brand-new financial services and products. In contrast, traditional financial institutions are isolated from each other. Trade barriers and integration costs hinder these institutions from making such combinations.
This unique feature of DeFi allows crypto assets to be used in multiple applications, thus drastically boosting the efficiency of asset management. For instance, DeFi users can borrow stablecoins from JustLend DAO, the official lending platform of TRON, and then commit them into SUN.io’s 2pool LP mining pool.
Now let’s talk about the risks. First, the security of smart contracts has long been a grave concern in the crypto industry. Hackers may exploit the potential vulnerabilities in smart contracts’ code and cause an immeasurable loss to DeFi users, making it crucial to select highly secured blockchain networks to participate in DeFi. A case in point would be TRON, which has recorded no security breaches since its launch and provides third-party security audit reports for its DeFi applications.
Second, DeFi’s capacity to combine different applications cuts both ways. If a DeFi application suffers a malicious attack or its underlying blockchain protocol is at risk, then all applications in the combination will be affected.
Finally, a decentralized financial system faces regulatory risks. Currently, DeFi applications are beyond the regulation of countries or regions, and there are hardly any regulators who oversee them. However, as cybercriminals increasingly exploit vulnerabilities in DeFi platforms to commit fraud, governments are developing policies accordingly, which will impact the development of DeFi worldwide.