Decentralized finance (DeFi) is changing the way we borrow or lend: Explained
Traditionally, borrowing and lending has required an intermediary such as a bank or other financial institution.
The bank facilitates the transaction and reduces risk by performing background checks using Know Your Customer (KYC) and credit scores.
Here, a borrower pledges goods, jewelry, etc., as collateral, and the lender makes loans and earns interest. The crypto industry is about to change the way this is done. How? It will do so through decentralized finance (DeFi).
The rapid rise of the $2 trillion industry has opened floodgates for innovation in the underlying blockchain technology.
This technology promises to cut out any middlemen like banks and allow the borrower to deal directly with the lender through smart contracts in a decentralized manner.
Simply put, smart contracts are self-executing electronic codes embedded in the rules of transactions.
These rules, for example, can be the amount of the loan, the fixed interest rates and the expiration date of the contract. These rules run on their own when the conditions assigned to them are met. There is therefore no need for the intervention of a third party.
People can get a loan by pledging crypto assets on a DeFi platform.
Similarly, users can deposit their crypto assets in a DeFi protocol smart contract and become lenders.
After depositing the crypto assets, the platform can offer them their redeemable native tokens to represent principal and interest.
But how can users identify the right platform to do this trade in the decentralized world?
One way to do this is to study the performance of the protocol by understanding its total latched value (TVL).
As the name suggests, TVL is an indicator of the value of assets staked in smart contracts on this platform. The higher the TVL, the more secure the platform.
Crypto users are rapidly moving to accept smart contract platforms, making them an important part of the crypto ecosystem.
Benefits include lower transaction cost, higher execution speed, and greater efficiency. It is also a transparent system.