What is decentralized finance (DeFi). Let's explain in simple words

Decentralized finance, or DeFi (Decentralized Finance) for short, has not yet become a part of our daily lives. However, this service sector is rapidly developing throughout the world.

DeFi is a form of providing financial services only without traditional intermediaries in the form of banks, funds, brokers, exchanges, etc. The entire operation of the system is based on blockchain technology and smart contracts.

What does this give to an ordinary person in ordinary life? Firstly, high speed of operations. Secondly, extremely low cost of maintenance.

Also, decentralized finance companies are developing and adapting to external conditions so quickly that they have actually built a full-fledged financial system from scratch in just a few years. Moreover, the crisis year of 2022 became the most successful for this segment, as it answered the request of people, “what to do when money is tight and it is not clear what will happen tomorrow.”

Nuances

What shapes the DeFi ecosystem:

Stablecoins are cryptocurrencies whose value is pegged to an underlying asset (for example, Tether USDT is pegged to the US dollar).
Pharming is any action aimed at obtaining tokens for any activity, as a rule, providing one’s computing power to carry out blockchain calculations.
Issue of tokenized shares. Essentially, these are analogues of traditional securities, but with the advantages of blockchain. There are several ways to use such tokens: debt or investment instrument, derivative, digital share. There are also baskets of tokens, which are the decentralized equivalent of ETFs.
Decentralized exchanges (DEX). They do not require an exchange operator, as well as the need for registration, identity verification and commissions. Instead, payments are processed by smart contracts. The platform does not gain access to funds and does not store the assets of its clients, that is, in essence, a real exchange takes place without an intermediary.
Loans in cryptocurrency. Some users provide their coins, while others take them. Decentralized platforms automatically enforce loan terms and distribute interest. To borrow money, you will need to provide collateral to the platform.
Synthetic assets are the creation of derivative financial instruments (derivatives) on the blockchain. These include contracts that simulate the price behavior of the underlying asset (stocks, bonds, options, futures, currencies, interest rates, etc.).
Prediction markets are platforms that allow you to bet on the results of events, games, elections, etc.
Asset Management.

Benefits of DeFi:

Easy access to financial services, especially for those who for some reason are excluded from access to the current financial system.
The rules for carrying out business transactions are written in a smart contract. Once it is launched, the DeFi application can run on its own with little or no human intervention.
Control over the ecosystem is evenly distributed among all network participants.
Transactions are completed quickly and without a chain of intermediaries, which reduces commission costs.
The source code of the applications is open for study, which allows any user to understand the functionality of the contract or identify vulnerabilities.
Anyone can create an application and use it. New services can be created by combining other products.
Unlike the traditional financial sector, there are no controllers or accounts that require filling out complex forms.

Disadvantages of DeFi:

No financial institution in any jurisdiction in the world is responsible for the actions of participants within the system. Therefore, you will not be able to ask for help or service. If a user loses a password or does something wrong, that’s entirely their problem.
High volatility, including interest rates.
Regulatory uncertainty: Authorities clearly do not like the inability to control financial flows, so they may impose bans or otherwise interfere with the operation of DeFi.
Lack of funds. Compared to loans in the traditional finance sector, the amounts that can be obtained with appropriate collateral are relatively small.
Infrastructure failures and smart contract hacks. If a critical error occurs in any of the protocols, there is a risk that the entire system will become vulnerable, through which one can penetrate to any point in the chain.
Fraud. In 2022, attackers stole more than $10 billion in investments using decentralized finance technology. Fraudsters issue dummy tokens and lure investors with promises of extremely high returns. The standard scheme is to wait until trading in the pool “warms up” and the price of the token jumps, and then withdraw all liquidity and disappear with the money.
Excessive hype. An overheated market risks bursting sooner or later.
Poor performance when a large number of transactions accumulate. Blockchains are inherently slower than their centralized counterparts.
Ecosystem disorder. Finding the most suitable application can be quite a challenging task.
The high cost of commissions for launching smart contracts, which can “eat up” all profits.

Why do we need centralized finance?

They enable the state to perform its main functions:

create a regulatory framework;
monitor compliance with legislative norms;
provide comfortable conditions for society;
regulate market relations;
stimulate new technologies.

State monetary systems are based on budgets. At first glance, they may seem isolated, but when solving large-scale problems, financial institutions are strengthened and a consolidated budget is formed.

A peculiarity of the use of centralized finance is that it not only provides the state administrative apparatus, but also forms the country's military reserve. Their stimulating function also plays a large role. It manifests itself through the redistribution of funds between enterprises and organizations in need in order to support an important economic sector.

Numbers

DeFi services have relatively few users. According to the Dune Analytics service, the total number of unique addresses in DeFi at the end of July 2022 was just over 3 million. In addition, according to the results of a study conducted by Chainalysis, more than 60% of transactions in the decentralized finance market were transactions with a volume of more than $10 million, which carried out by large investors. That is, in the early 2020s, the decentralized finance market is more of a closed club than a product for the masses.

Features of centralized finance

They are a subsystem, the main link of which is the budget system; it depends on the form of government. The state budget is the main centralized fund, an instrument that allows for the effective redistribution of funds. Its main expenses are:

performing political functions of the state;
resolving issues regarding social needs;
introduction of investments in certain sectors of economic infrastructure.

Regional needs for money are provided by local budgets. They are distinguished by their independence. Most of these funds are used to address social needs. Additionally, they may receive assistance from the state in the form of subsidies, grants, and issuing loans against government obligations.

Centralized finance has its own operating principles. They make it possible to identify the direction of the impact of cash flows on the development of the state or municipal sector. The basic principles include:

Use as a base based on information flows. Analysis of incoming information is important both when making a decision and in the process of monitoring its implementation.
Clarity of orientation. All centralized finance affects certain interests of society, but in any case they are focused on solving centralized problems.

Thus, the main functions of centralization include planning, organization, and control. The formation and distribution of financial funds is carried out by the state. For this purpose, within the framework of various regulations, sources and priority areas for movement are determined. This is also one of the main differences from decentralized finance, for which strict control is not established.

Features of the formation of state revenues

The creation of state revenues as an integral part of the budget has its own specifics. The formation of the revenue part is influenced by the form of the state structure, the relationship between administrative-territorial units based on the distribution of powers.

There are two main forms of government. devices: unitary and federal . With the first type, the budget consists of two levels: state and local, and with the second - of three: federal, level of subjects of the Federation, local.

There are other factors that influence the formation of state revenues. They are divided into internal and external .

Internal factors:

scale of the country: with a larger number and wider scale, it is logical to have a larger amount of funds coming into the budget;
provision of natural resources makes it possible to reduce the cost of purchasing them for domestic consumption, as well as export them to generate income;
The current state in which the economic sector is located suggests that the more economically developed business entities are, the greater the amount of income that will flow into the budget due to a natural increase in the tax base (it is assumed that government spending to support those sectors of the economy that are in unprofitable condition);
tax system: a simple, understandable, effective tax policy that does not overload business entities and the population, while stimulating and motivating to pay taxes, will logically lead to an increase in the number of taxes to the country’s budget.

External factors:

the level of state integration into the global financial system indicates the country’s ability to quickly adapt to negative changes in the global economy and reduce the overall impact on the state economy, as well as on income generation;
state of solvency of the state: with a negative balance, there is an outflow of capital to other countries, which can increase the amount of public debt, as well as the budget deficit.

Among the above-mentioned factors, a couple of the most significant ones can be identified: tax policy and the degree of integration of the country into the global financial system. The importance of the first factor is obvious (most of the state revenues come from tax payments). The importance of the second is worth explaining in more detail.

How does it affect the income side? This factor has an indirect or indirect significance: due to integration into the global financial community, the likelihood of increasing the state's resistance to various kinds of negative trends increases. Most likely, the level of economic development will also begin to increase, which will inevitably lead to an increase in budget revenues.

Principles of income generation

Income is not generated randomly. There are fundamental principles for creating budget revenue.

These include the principle:

unity;
independence;
distinctions between budgets;
equality of budgetary rights at all levels;
completeness of income reflection;
reliability;
box office unity.

Now it is worth considering each of the proposed principles in more detail.

The principle of unity means that the basis for the formation of revenues at each level of the budget is the same legislation.

The distinction between budgets occurs on the basis of the Tax Code of the Russian Federation, as well as the Budget Code and other legislative and regulatory acts.

Budgets implement the principle of independence in planning the revenue side of the budget, as well as in their use.

The same requirements apply to budgets of any level .

Each income contribution must be reflected in reporting based on the actual facts of economic activity.

And the last principle - cash unity - involves crediting each receipt to a single budget account.

Thus, on the basis of these principles and in accordance with the powers of certain authorities, budgets are created at the very initial stage of planning or a draft budget is drawn up, presented in specific indicators.

The essence of state and municipal revenues

State and municipal revenues act as a source of financing for state and municipal government, the activities of state and municipal government bodies and their needs.

State revenues are credited to the budgets of the state budget system at various levels, as well as off-budget funds for special purposes. Municipal revenues are credited to municipal budgets and municipal extra-budgetary funds.

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Part of state and municipal revenues remains at the disposal of state and municipal enterprises.

The system of state and municipal revenues is based on the principle of unity. The essence of this principle is that Russian legislation determines the types of state and municipal revenues, the procedure for their distribution between the federation, regions and municipalities. In this regard, the presence of certain sources of formation of state and municipal revenues ensures the widespread use of the same types of cash receipts.

How does a decentralized control system work?

The DeFi management procedure is of great importance for the stable functioning of the institute. It involves developing programs and identifying the most promising areas for distributing funds. Resources are used for:

Repayment of borrowed funds, payment of interest rates.
Fulfillment of financial obligations established by law.
Covering expenses related to the expansion of production (increase in working and fixed capital, investments related to technological re-equipment, modernization, reconstruction).

Within the framework of a market economy, monetary relations are based on basic provisions, compliance with which allows the system of decentralized finance to function effectively. They are able to guarantee the stable operation of the economy and the social sector, making income the basis for the development of the entire system.

The approach to DeFi management plays an important role in the stability of operation. The constructed algorithm ensures the development of programs and determines the most promising areas for financing.

Resources you can use:

To fulfill obligations to the creditor, as well as those provided for by law.
Financing expenses associated with business expansion, increasing authorized capital, and modernizing equipment.