Decentralized Finance and Small
Decentralized finance, or DeFi, had a resurgence last summer and is still emerging as a tool for small businesses in developing markets, particularly for remittances and small loans. But what exactly is DeFi?
Decentralized finance, or DeFi, had a resurgence last summer and is still emerging as a tool for small businesses in developing markets, particularly for remittances and small loans. But what exactly is DeFi?
Decentralized Finance Defined
According to specialists, DeFi uses the blockchain to build applications, protocols, or tools that allow small businesses to conduct transactions in a way that reduces the need for other third parties to verify the deal. It is a resource that develops a peer-to-peer dynamic, where users interact and define parameters based on their needs. At the same time, the software serves as the middleman assuring the terms.
Who is Using DeFi?
Since its inception, DeFi-based forms of finance that do not rely on centralized intermediaries have been adopted by smaller businesses in developing markets whose needs are unmet by traditional banking systems. Today, founders are foundering because, instead of lending, banks are choosing to raise their cash reserves and purchase U.S. Treasuries in advance of the next market downturn. Unfortunately, many small business owners do not have that option as they battle inflation and employee turnover, so DeFi has become the following option to keep them open.
Benefits of DeFi for Small Businesses
DeFi platforms provide an alternative system, not simply a plug-in to existing banks. Their decentralized nature means transaction onboarding and market-based risk assessments are much easier to scale across a business’ broader system because access to relevant information is not dependent on centralized processing or a prior relationship. Before DeFi, a company would have to complete anti-money laundering and “know your customer” checks for every source of capital and convince their counterparts to onboard to the same transaction banking programs. They also would not be able to present evidence of performance on their debt or payables outside of financial statements.
Risks of Decentralized Finance
While DeFi holds is promising for many small businesses, some risks need to be noted:
- DeFi is not regulated, so if your DeFi account gets hacked, the U.S. Securities and Exchange Commission can’t help and provide recourse.
- DeFi accounts are not FDIC insured. If your funds get stolen, they cannot be recovered.
- DeFi smart contracts are software that can experience programming bugs or glitches which could lead to account hacking.
It’s worth noting that traditional banking is susceptible to experiencing hacking and theft, and DeFi is similar in that aspect. Nevertheless, DeFi has the potential to keep small businesses up and running on their terms while banking continues its steady retreat from relevance on its terms.
