Between 2010 and 2020, French Fintech startups raised more than 2.5 billion euros. With the advent of contactless commerce and negative interest rates, the banking and financial sectors are undergoing profound changes. In addition, the media frenzy around cryptocurrencies and generally everything based on a Blockchain sharpens the interest of investors and users alike.
Originally, Fintech (contraction of “financial technologies“) referred to all the IT and digital tools used to improve or automate financial services.
Behind this term, we find many technologies, practices, and services ranging from mobile budget management applications to expert systems based on artificial intelligence to detect and anticipate fraud cases.
The evolution of technology sometimes makes you dizzy. Thus, innovative financial technologies (Fintech) are making significant inroads worldwide. In the banking sector, Fintech is disrupting essential financial services and pushing banks to innovate so as not to be left behind.
For consumers, they open up the possibility of broader access to better services. While most Fintechs are still small in size, they can increase with customers and in more risky segments than traditional lenders.
However, this rapid growth and increased prominence of Fintech-provided financial services in financial intermediation may pose challenges.
Therefore, rather than Fintech, the market is now talking about Decentralized Finance (DeFi for “Decentralized Finance”) as an alternative to the traditional system, which relies on the systematic use of institutional intermediaries.
The idea of what DeFi means for Fintech will be the main topic of this article. You will also see how DeFi works and its application in Fintech. Finally, this article will discuss the future of DeFi in Fintech.
What is DeFi?
DeFi is the acronym that unites Finance and Decentralization. Thus, DeFi stands for Decentralized Finance. DeFi refers to a series of financial applications capable of making citizens independent of banks, insurance companies, and other institutions.
However, the critical point of DeFi applications is that they are not tied to a given company; they rely solely on smart contracts. Once the application has been programmed, it works by itself.
Therefore, this results in minimal costs for the user since there is no structure to maintain, offices to rent, or intermediaries to remunerate. Moreover, the registration procedures are reduced to a strict minimum. As a result, DeFi-based insurance will be very inexpensive and flexible in the real world.
It aims to provide the same financial services delivered by traditional institutions but with properties inherited from cryptocurrencies. It works peer-to-peer, relying in particular on smart contracts.
Put simply; it is finance without banks. In the world of DeFi, traditional banking services are being replaced by smart contracts and algorithms. DeFi represents the ecosystem of applications within which it is possible to generate passive interest by depositing, lending, or borrowing cryptocurrencies.
This universe brings together many decentralized finance applications developed in recent years on most known Blockchains, such as Ethereum, Avalanche, Solana, or Terra.
For a DeFi application to take off, it is necessary that users are spontaneously interested in participating in it, investing their ETH (Ethereum), BNB (the currency of Binance ), or other cryptos.
To this end, rules in a DeFi application are enacted in the smart contract to reward those participating in the application in question. In addition, those who invest in the cryptocurrency linked to a given application receive “governance tokens,” which authorize them to vote on the evolutions of the application.
How does DeFi work?
DeFi operates on the principle of decentralization. So, unlike all fiat currencies currently existing, the cryptocurrencies supported by DeFi are not pegged to a central bank. This mainly means that no one controls them, and their course is free.
Moreover, by functioning thanks to the Blockchain, the transactions that take place in DeFi are visible and accessible to all. It is not a private register, which can only be consulted by banks. Any Blockchain user can trace a transaction: its amount, origin, recipient, date, etc.
Most financial services defined as DeFi use the Ethereum Blockchain, which notably allows the use of smart contracts. These contracts, specific to the Blockchain, make it possible to keep a public register of transactions, thus avoiding the need for intermediaries who guarantee the accuracy of the transaction.
It is, therefore, essential to understand the operation and the very principle of the Blockchain to understand DeFi. If we had to summarize it in a very simplified way, we could say that the Blockchain is a chain of blocks that groups, synchronizes, and timestamps all the transactions that take place between the Blockchain users.
In doing so, no one controls it since each block is added, checked, and validated by Blockchain users. Therefore, no supranational authorities could limit or regulate its operation.
For decentralized finance to work, it needs infrastructure and a currency. The infrastructure could come from the Ethereum platform, which allows you to write decentralized programs and create smart contracts.
You could even build dApps to establish financial services on the Ethereum Blockchain. The currency used here could be cryptocurrency, but most cryptocurrencies are highly volatile. That’s where stable currencies (stablecoins) come into the picture.
How is DeFi applied in fintech?
Internet-based financial services are being offered more frequently every day. This has caused a number of economic models to arise, each of which aims to provide consumers with a variety of products that simplify financial transactions, including tools for buying or dealing in cryptocurrencies.
Fintech and DeFi are currently the two solutions available for providing financial services via the web. Improved user access to financial services is the goal of both solutions. The old financial system has mainly worked on the same model for over a century.
Everything depends on the same banking industry, exchanges, insurance companies, central banks, etc. The fundamental structure has remained constant and centralized despite all technological advancements and related advances.
Fintech has recently sparked some disruption and assisted in lowering transaction costs. But because Fintech is based on the same centralized financial system, there is a limit to how much efficiency can be gained and how low expenses can be.
That restriction is not present with decentralized finance. The application of DeFi will help solve the following problems: inefficiency, limited access, opacity, centralized control, and interoperability.
Reducing inefficiency means eliminating fees and intermediaries. For example, a significant issue facing the entire world is restricted access to the financial system. By removing these obstacles, millions of people could get access to the financial services they require.
Concentration and centralized control are crucial components of the modern financial system. A prime example is the market power of commercial banks. This indicates that borrowing rates are higher than they ought to be and savings rates are lower than they ought to be.
But DeFi is different. It’s highly competitive. Finally, interoperability is an unavoidable structural problem. Multiple platforms and systems cannot connect with one another due to various barriers.
For example, to open an account with an e-commerce entity, a person might have to transfer money from a bank account. Before the new account is available to trade, the process could take several days. It’s vastly different from decentralized finance. You visit an exchange with a wallet in hand, connect it, and you’re good to go.
Examples of applications of DeFi for fintech
There are many examples of application of DeFi for Fintech. Some of the popular ones are:
- KYC Verification
The application of DeFi is being widely used for authentication, verification, and electronic record storage in the banking industry, as well as creating a KYC utility for stock exchanges.
- Record Storage and Management
Documents in physical and digital form can be modified and copied. While there are many products and services that provide secure and verified document engagement, they tend to be expensive and often require the involvement of a third party. DeFi embeds authentication into the document itself and uses a closed-loop to protect against tampering or modification. An example can be the Indian startup Recordkeeper, which allows customers to immutably store documents, data, and any transaction on a private Blockchain securely without the need for a central authority.
- Remittance Simplification
Blockchain remittance companies’ primary objective is to streamline the entire process by eliminating extraneous intermediaries. The idea is to provide frictionless and almost instant payment solutions. Unlike Fintech, DeFi does not rely on a slow transaction approval process, which typically goes through multiple mediators and requires a lot of manual work. Therefore, DeFi can solve the remittance industry’s significant problems, such as high fees and long transaction times.
- Credit Score
Fintech companies could use DeFi to serve the unbanked population that lacks credit scores and helps them obtain credit.
- Secure Digital Regulatory Process
Blockchain immutability lends itself to the application of proof of process for compliance. For example, DeFi could be employed to record the procedures necessary to comply with regulations. Recording actions and their results immutably on a Blockchain could create an audit trail for regulators to verify compliance. For example, Bangalore-based Signzy Technologies offers Blockchain AI-based digital trust solutions, aiming to simplify and secure Digital Regulatory processes.
- Supply Chain Financing and Management
DeFi enables significantly higher settlement turnaround time at lower costs by providing a single source of truth about critical points in the supply chain, such as creditworthiness, supplier inventory levels, receipt and approval of purchase orders, receipt and acceptance of invoices, and more. Delhi-based Sofacle Technologies is one startup that designs and develops Blockchain-based business solutions for smart contracts, supply chain finance, and insurance, among others.
What the future holds for DeFi in fintech
With DeFi or Decentralized Finance, millions of new users are now borrowing, lending, trading, saving, and doing more without any permission of the companies whose interests may not align with their customers or buyers.
The DeFi sector is growing day by day constantly in terms of users and also total value. But the fintech industry could also be impacted by this. It is undeniable that the introduction of DeFi is pushing the financial sector into the unknown.
DeFi startups are growing and will influence the direction of finance. The overall impact of decentralized finance cannot yet be predicted, although early indications have shown both its benefits and drawbacks.
Decentralized finance has become the gateway for many new functionalities. Technology is useless if it cannot be put to use. That is why DeFi has been configured as a critical element in carrying out numerous operations. An example of all the cases we can give to DeFi is banking-type services.
DeFi technologies, being financial systems, offer a large number of “banking” type services. These are undeniable use cases of these decentralized finances since they allow banking operations such as the issuance of digital currencies, loans, or insurance.
There are many use cases for these new decentralized finances. Thus, they are configured as a movement that allows you to request loans, carry out banking operations, tokenize assets, or the creation of decentralized exchanges (DEX), among others.
This fact in itself already shows that this new financial movement is here to stay. DeFi is advancing at a dizzying speed, and new concepts have been created in relation to this technology, further proving that the future of these finances lies in today’s markets.
Conclusion
Fintech and DeFi aim to guarantee user access to financial services of all kinds via the Internet, including cryptocurrency transactions and trading. However, both systems work differently.
While Fintech ensures the safety of funds and fair trade, DeFi is much more accessible and creative. It provides a space for investors to implement their strategies without having to depend on an intermediary entity in a global ecosystem that knows no borders.
Both systems have their pros and cons. Choosing one model or another depends on the needs of each particular investor. For example, DeFi is a suitable model for you if you prefer transparency and privacy.
DeFi is in apparent exponential growth. Although DeFi has the potential to revolutionize global finance, activity yet has centered on speculation, leverage, and making money for the community of holders of digital assets.
Ultimately, DeFi’s success or failure will depend on whether it can deliver on its promise of open-to-all, high-trust, and unguarded (guarded) financial services.
See you soon,
Scaling Parrots
