Decentralizing Centralized Finance: Finding A Way Forward
Decentralized finance is taking multiple industries by storm, and new use cases are consistently being launched around the world. The rapid growth of this sector has been fueled in part by the public’s growing disillusionment with traditional financial systems and processes, and in another by a desire for modernity, ownership and transparency.
Decentralized finance is being lauded as a solution which is putting control back into the hands of the user, during a time when data ownership and online privacy have been on the forefront of communal concern. Even more impressively, these solutions are simultaneously lowering the entry requirements of the finance industry which were previously often inaccessible for many. The DeFi systems that are being developed now will likely have an effect on the financial industry long into the future.
What Is Centralized Finance?
Centralization refers to a central point of control in a business, industry or offering, in this case financial institutions like banks. In the past, centralization was used as both a measure and maintainer of stability in financial processes as they were thought to be more secure than individual and personal management. These two key components helped forged centralized systems into the world of finance. The problem is that these centralized financial systems have historically been affected by a multitude of issues such as fraud, forgery, questionable lending processes and more- not the perfect track record wanted from those handling finance.
Centralized financial systems aren’t always stable either. The majority of the world owns a smartphone and has access to the internet, but many countries still struggle with banking accessibility and reliability of financial service providers. High fees, corruption, hacking and other concerns have caused a demand for an alternative.
What is Decentralized Finance?
Decentralized finance describes a new type of financial system that is distributed and built on open source networks like Bitcoin and Ethereum. Decentralized finance can offer many improvements to current financial systems across the globe. These systems have no central point of control, making manipulation or fraud much less likely, while still maintaining the capabilities needed for transactions to take place reliably and transparently.
For underbanked communities, or communities facing financial upheaval, this is a beacon of light- with little more than an internet connection individuals can suddenly participate in a global financial trading market. Development of these systems is snowballing and it isn’t difficult to see why: centralized finance is inaccessible, inconvenient and expensive.
With decentralized finance, another possibility is grabbing attention: lending. Through the use of public blockchains, loans can be granted on decentralized systems almost instantaneously and across borders by using smart contracts. Smart contracts are programmable auto-executing digital contracts which execute agreed upon terms and which can be applied to assets. Decentralized lending technology is said to soon be able to match lenders with financing, help them manage risks, data, transactions and many other exciting applications.
Perhaps the biggest benefit of these decentralized systems are their open protocols which allow decentralized finance developers to create interoperable systems and services at very low costs, something the centralized financial industry has been unable to achieve so far.
Solving The Scaling Issue
There is one obstacle left for decentralized finance systems to overcome: scaling. Centralized financial systems currently process enormous amounts of transactions per second which decentralized systems have been unable to replicate thus far. Scaling solutions are being developed, such as the Lightning Network which adds a second “layer” onto the Bitcoin or Ethereum blockchain. The Lightning Network’s approach is to minimize the amount of transactions taking place on the blockchain, by opening a dedicated private “channel” between two users wanting to transact, and maintaining that channel until such a time that set terms are met.
With successful implementation of this technology, decentralized transaction times are set to increase to close to a million transactions per second.
The scale of development taking place in decentralized financial services and applications is reflective of the public’s need to take back ownership of things like their private data and finances. Centralized finance seems more trustworthy because of its legacy, but if it’s not providing the accessibility, security or stability wanted from the financial industry then it is natural for alternatives to develop and gain traction.
The potential that decentralized options are bringing to finance is both contributing and a result of a global demand for change. Decentralization is still in its infancy today, but could have a significant impact on the way financial transactions are handled in the future.