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What is DeFi and how it is different from CBDC and UPI?

Mon Feb 27 2023

From the barter system to paper currencies, to digital finance, we have come a long way. While cash is still the king but digital currencies and digital payment methods are taking over rapidly. Decentralised Finance (DeFi) has been a game changer in recent times, which has been disrupting the entire financial organisational structure and the way payments and currencies work. In this article, we will see how DeFi works, and its benefits while also understanding how it is way different from CBDC and UPI. 

What is DeFi?

Decentralised Finance (DeFi) is referred to different financial services that are performed using blockchain technology, especially on the Ethereum blockchain. DeFi supports most of the transactions, and functionalities of any bank such as borrowing, lending, buying insurance, trading, investments, earning interest on deposits, and a lot more. However, the time taken for performing the functions or offering the services is less due to no involvement of third parties and paperwork. It is all digital and direct between the client and the platform. Cryptocurrency, which is also one of the forms of DeFi, is popular globally and offers peer-to-peer payment services and other financial services without any intermediaries and is also not controlled centrally. This is why it is known as Decentralised finance, which is not centrally monitored and controlled. 

How does DeFi works?

Decentralised Finance or DeFi works through software or applications like the ones you use on your smartphone. These applications run mainly on the Ethereum blockchain and here you do not have to go through a complex onboarding process to use the applications. You can download the applications and start using the same. 

Here are the top usages of DeFi apps in today’s world – 

  • Lend and earn: You can lend your crypto holdings if you have any to earn interest on the same. Since DeFi lending apps are peer-to-peer lending apps, you can easily lend your crypto holdings to another user directly without much ado. Lenders usually earn interest on the value of cryptocurrency lent every minute, yes, it is not per month or annually, it is every minute, and the lender can earn interest. 
  • Short-term borrowing: Banks and other financial institutes have a lot of formalities and criteria to be fulfilled to offer you a loan but with these DeFi apps, you can easily avail of flash loans which are short-term loans for your usages when required. 
  • Trading and investments: DeFi apps have made trading and investments into cryptocurrencies super easy. You can easily trade cryptocurrencies anytime using these applications while you can also buy and hold the currencies for long-term investment purposes. Here there is no stock exchange or SEBI or depositories for which you need to open a Demat account and trading accounts. You can simply open a DeFi app and select the token you want to trade or invest in, then click on buy or sell and enter the amount, and click on submit, it will be done. You can check the same in your wallet on the application. 
  • Trading derivatives: With stocks and other assets you may have traded in derivative contracts, now with DeFi apps, you can trade crypto derivatives too. 

How DeFi has been changing the game?

DeFi has been made to overcome the shortcomings of the traditional banking sector. In the conventional banking sector, there is a lag in every department due to manual procedures, which DeFi is mainly targeting to solve. 

DeFi has been offering ‘open to all’ facilities, where you just need to create a wallet on any of these DeFi apps and then get started. You can even use the application as anonymous which is one of the best things about decentralised finance, however, this is a bit risky, as this increases the chances of fraudulent activities too. 

DeFi apps are super flexible, unlike conventional banking applications. You can transfer, make payments, buy and sell, and make other transactions without paying any hefty fees or waiting for permissions. This also cuts down on the time taken for the transactions to happen. DeFi apps offer transactions which are faster than transactions happening on Wall Street as per some studies. 

DeFi vs. CBDC vs. UPI

Now that you have an understanding of DeFi, let’s see how it is different from CBDC and UPI. 

  • Control: While DeFi is itself the short form of decentralised finance, CBDC is Central Bank Digital Currency, which is centrally monitored and controlled by RBI. UPI on the other hand is monitored as well. 
  • Nature: DeFi is the term given to the universe of peer-to-peer financial services while CBDC is the digital form of the rupee and UPI on the other hand is a payment system. So, all three are different from each other. 
  • Usage: The components of DeFi or the services which are offered by the DeFi apps at present include almost all kinds of financial services. On the other hand, UPI is mainly a payment system which is used to make online payments easily without much hassle lastly, CBDC is the currency itself which is used for making transactions digitally. 
  • Approval: CBDC being the central government’s digital rupee, is undoubtedly a legal tender. UPI is legalised in India as it has been developed here and finally, DeFi is still unregulated and unorganised so, still not legally approved. 

Wrapping up

Whether it is DeFi, CBDC, or UPI, all will be a part of the future financial system. While UPI has become quite popular in India, and it is also getting accepted worldwide slowly, DeFi is still on its way to making its presence felt in this economy, and CBDC has just made its debut, so, we need to wait to see how it turns out to be. 

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