One of the hottest debates now in financial markets is whether to continue trusting humans or embrace new technology.
The blockchain technology that was initially limited to crypto trading is radically finding its way into other financial ecosystems, affecting institutions such as banks, mortgage lenders, and insurance companies, courtesy of the latest invention—Decentralized Finance (DeFi).
This huge milestone is geared towards addressing the many weak links associated with Centralized Finance (CeFi) and its predecessor—Traditional Finance (TradFi). Despite the inherent challenges, CeFi continues to dominate most markets up to date.
As both spaces scale higher by the day, it’s essential to understand basic principles and how they relate to each other. So in today’s blog, we dive deep into DeFi and CeFi to explore what they are, their differences, pluses and minuses, and how they affect mortgages and the real estate industry at large.
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Centralized Finance comes from the concept of centralized markets, where we have only one exchange entity from which all associated stakeholders transact. Typically, these entities are either monopolies, oligopolies, or government institutions with little or no competition. And that means they have the final say about the terms by which buyers and sellers trade.
From the outset of cryptocurrency, CeFi has continued to rule the market, with many platforms coming up every day, for instance, Coinbase, Binance, and Hodlnaut.
Similarly, intermediaries such as banks collect funds from investors and lend them out to mortgage borrowers. Note that this involves both primary and secondary mortgage markets.
Decentralized Finance aims to disintermediate the transaction process between the two parties to solve the underlying CeFi problems. These DeFi platforms are built on top of the public blockchain using smart contract technology to facilitate services such as lending and borrowing, yield farming, and asset storage.
The fact that the entire process is automated implies that all terms, conditions, and necessary documentation is predefined while building the software.
In the end, cumbersome manual processes such as mortgage lending that could take days in CeFi can now be executed almost instantaneously, saving time, resources and improving efficiency.
The intermediary accumulates funds from multiple investors and stores them in a common pool from which they can trade. For instance, crypto exchange platforms like Coinbase and Binance collect user investments and store them in their internal account.
The main challenge with this is the high levels of cyberattacks it attracts. Instances like the JPMorgan Chase data breach of 2014 that affected millions of customers remain a nightmare. The exciting part about CEX is that most have well-established customer support systems that come through for customers during uncertainties.
Prices on these platforms are available for anyone. This allows potential investors to evaluate the quotes and trades against their goals to make informed decisions before investing. It also simplifies the entry process.
However, pricing on centralized platforms is more unstable than DeFi when converting cryptocurrency into fiat money and vice versa.
A clearinghouse or clearing division sits between buyers and sellers in a financial market to ensure everyone honours their contractual obligations. The intermediary section helps improve the integrity, which translates to lower risks integral in any financial market.
Intermediaries in CeFi are replaced by blockchain tools like smart contracts and dApps that auto-execute when the specified conditions are met.
Everyone in the network has equal rights—they engage at a peer-to-peer level. If anyone wants to have any modifications, there has to be a consensus between all parties. The concept of distributed ledger also allows everyone to access the same ledger that records asset transaction history.
In conventional financial systems, the financial institutions are directed to constantly evaluate their customers to ensure they comply with KYC requirements to limit fraud. This is great, but what about creating secure, fraud-proof systems that guarantee safety without asking for personal information? This is all possible, thanks to blockchain.
Software developers looking to develop blockchain tools can also do so conveniently without being bogged down by anti-money laundering requirements or incurring any cost.
When we bring money into the conversation, trust and security cannot be underestimated. The cool thing about DeFi is that once deployed, for instance, on the Ethereum blockchain, the code cannot be modified without bringing down the entire system. Therefore, the program will always work as designed.
Blockchain’s hashing functionality helps keep all transactions on the distributed ledger in check. For any data appended on the blockchain, a corresponding hash code is generated to represent the data. The code serves as a reference to the original data and helps encrypt data in cryptography for advanced security.
Both Decentralized Finance and Centralized Finance have the same goal but different approaches. And in mortgages, it’s solely to connect mortgage lenders and borrowers.
Mortgage lending institutions that use CeFi report a lot of inconveniencing setbacks that have been fully addressed by DeFi. From low mortgage processing rate and potential lending risks to compromised security and trust in CeFi, it’s genuinely time every mortgage lender reevaluates their progress and considers the promising capabilities DeFi has to offer.
What is even more interesting is, Fundmore.ai comes in at the loan origination stage to automate the underwriting process so you can do less and achieve more.
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