Powered by blockchain technology, Decentralized Finance (DeFi) or Open Finance has emerged as a sweeping wave of innovation facilitating highly liquid and interoperable financial services in absence of a centralized intermediary. DeFi users can gain permission-less access to highly liquid products such as loans, insurance, payments, margin trading, and more, while holding custody all the while. Compared to conventional finance, DeFi allows lower entry barriers to financial markets, unprecedented transparency, and better competitive offerings for financial products.
It will be perfectly alright to term DeFi a decentralized application environment which is providing a new dimension to the financial ecosystem. DeFi achieves this by replacing intermediaries (banks– for example) with self-execution technology (smart contracts) to reduce cost, bring agility and increase liquidity while offering almost full ownership controls to the investors.
Smart contracts – the nerve center of DeFi
Smart contracts, used as an underlying technology by DeFi, are self-executing contractual agreements written in computer languages. The conventional contract terms are embedded into the code and these automatically execute when the stipulated conditions are met. To ensure verifiability of transactions, a permanent copy is saved on the relevant Blockchain ledger that can be verified on any net-enabled device by community members.
Built on the principles suggested by Nick Szabo, an eminent computer scientist and cryptographer, smart contracts are about embedding disparate contractual clauses, regardless of their nature, format, and purpose, into software designed to facilitate easy execution of valid transactions. Smart contracts discourage any sort of breaching or frauds by making it restrictively complicated.
These automated contracts act as a base for auto-executing value exchange between parties where human trust is to be replaced by predictable if-then processes. In other words, if the predefined conditions meet, the corresponding contract is executed. A simplistic example of a smart contract would be a ticket vending machine where a shopper will get the ticket, if they insert the right amount at the right place.
Role of stablecoins in DeFi
Stablecoins are the cryptocurrencies with their value hooked to a specific reference or asset like gold, euros, and dollars. These are further divided into fiat/asset-backed, crypto-collateralized, and algorithmic stablecoins. The Fiat/asset-backed stablecoins are tethered at the ratio of 1:1 by a private entity asset. For instance, Tether is one such stablecoin backed