How Decentralised Finance is Revolutionising Traditional Finance 

Authors:-Aditya Phad and Shi Ying Lim

 Introduction

Decentralised finance  refers to any application that uses blockchain and cryptocurrency technology to offer financial services. Some decentralised finance applications can provide basic to advanced services like lending, borrowing, trading, and yield farming, all executed through smart contracts (OSL, 2025). An example of a notable decentralised finance service provider is Aave, which allows anyone to participate as a liquidity supplier or borrower. It lets you stake any of your crypto assets to earn interest income from users who might borrow your assets (Sharma, 2024). As opposed to traditional finance, decentralised finance operates without centralised intermediaries like banks, allowing users to transact directly with one another (OSL, 2025), thereby reducing costs and transaction times. Traditional finance is highly regulated but can be more inefficient than decentralised finance, while decentralised finance promotes greater efficiency but is often seen as more volatile.

Statement of the Problem

Traditional finance is plagued with inefficiencies in the form of high transaction costs, delayed cross-border payments, limited access to financial services, and monopolistic control by centralised intermediaries. Such issues pose challenges to individuals and businesses, especially in underserved or unbanked regions. Furthermore, reliance on a handful of centralised intermediaries increases the possibility of market manipulation and financial instability. Decentralised finance facilitates this by creating a decentralised, open, and transparent financial system that operates without the need for intermediaries. Decentralised finance systems allow individuals to engage in a wide range of financial activities like lending, borrowing, trading, and investing directly on blockchain networks. Through the use of technologies like smart contracts, decentralised finance makes automated and secure transactions. This model has the potential to eliminate inefficiencies, reduce costs, and provide financial inclusion for a greater global population, which can redefine the practice of finance (Kumshe et al., 2024).

 How Decentralised Finance Works: A Beginner’s Guide to Decentralised Finance

To delve into greater detail about how exactly decentralised finance works, we will explore its components. Components of decentralised finance include decentralised exchanges, stable-coins, Stable-Swap, liquidity mining, margin derivatives, and aggregators. These components work on decentralised exchanges, a peer-to-peer marketplace where cryptocurrency transactions occur. Whereas Stable-Coin is a cryptocurrency pegged to a stable asset such as gold, diamonds, oil, or fiat. Backed by tangible assets, stable-coins have a stable value over time and have minimal price fluctuations. While stable-coins are an indispensable component in decentralised finance, we may need to own more than one type of them, but that will result in scattered assets, which makes it difficult for users to make the most of their capital when participating in the market. This is where Stable-Swap serves its purpose of converting Stable-Coins to serve many needs, ensuring low transaction fees and slippage. Liquidity mining refers to making profits from decentralised platforms by providing liquidity to those platforms. It rewards users accordingly (in the form of LP tokens) based on the liquidity they provide for a cryptocurrency pair in the decentralised platform pool. Margin derivatives are derivatives of the performance of the underlying crypto assets and are used as a financial tool to help users hedge against the possibility of substantial price fluctuations from the crypto market. Lastly, decentralised exchange aggregators use complicated algorithms to get the best liquidity prices for users from different exchanges, allowing users to access a wide range of trading pools through a single interface. This saves users time and the efficiency of cryptocurrency transactions. (Ash Swap Academy, 2023). These components of decentralised finance work harmoniously to facilitate greater efficiency during user transactions.

Decentralised Applications  and Their Role in Decentralised Finance

Decentralised Applications  are blockchain-based and not controlled by a central server, with greater transparency, security, and self-governance. Decentralised applications are network-based, not like traditional apps relying on central servers and middlemen, and offer trust-less interaction. These applications use smart contracts—self-executing code on the blockchain—to execute transactions and automate processes without human action (Investopedia Team, 2024).

Decentralised apps in decentralised finance are the backbone of financial services, with users being able to lend, borrow, trade, and earn yields without the intervention of the banks or brokers. Lending Aave (Aave,2020) and Compound enables users to earn interest on deposits or borrow against crypto assets as collateral. Decentralised exchanges (DEXs) Uni-swap (Uniswap,2020) and Sushi-Swap (SushiSwap,2020) allow peer-to-peer exchange using automated market makers (AMMs) rather than order books. Yield farming and staking offer users passive income streams through the provision of liquidity to decentralised finance protocols.

Though useful, decentralised applications are not immune to problems where cybersecurity is a giant issue. Weaknesses in smart contracts and zero-day exploits have led to multi-million-dollar hacks, exposing the ecosystem’s vulnerability. Without proper auditing and security, applications are vulnerable to attacks. Scalability is also a problem, as severe network congestion could lead to high gas fees and slow transactions.

Despite these, decentralised apps are evolving, offering new financial solutions outside the scope of traditional banking systems. By eliminating intermediaries, offering greater transparency, and enabling financial inclusion, decentralized finance and decentralized applications are transforming the financial world, making decentralized finance a viable alternative to traditional economic systems. 

Decentralised Peer-to-Peer (P2P) Borrowing and Lending Platforms

Decentralised Peer-to-Peer (P2P) lending platforms use blockchain technology and smart contracts to enable direct lending between users, without the use of traditional financial intermediaries such as banks. Borrowers submit loan requests as amounts, interest rates, and tenors, and these are encoded into smart contracts. The requests are channelled to lenders who fund loans that they deem feasible. On full funding, the smart contract disburses the borrowed amount to the borrower, enables repayment, and levies penalties in case of default (Kumar et al., 2024).

Advantages Over Traditional Lending

Decentralised P2P lending has some benefits. By eliminating intermediaries, it saves costs in a big way, making loans more affordable. Algorithmic interest rates guarantee competitive rates depending on demand in the market. Decentralised platforms also enable access to finance for individuals without traditional credit history, based on collateral on-chain rather than credit history. Blockchain transparency guarantees all deals and loan terms are publicly visible, reducing the risk of fraud (Kumar et al., 2024).

Decentralised Finance Risks: Smart Contract Vulnerabilities, Scams & Hacks

Decentralised P2P lending is not without problems despite advantages. Most platforms use overcollateralization, where borrowers provide more than they want to borrow, thus denying access. Credit risk is a problem since no central agency will authenticate borrower credibility. Secondly, smart contracts, as automated as they are, are prone to bugs and exploits, leading to potential financial loss. Uncertainty about regulation is also a problem because governments everywhere want to impose compliance requirements on decentralised lending platforms. Threats aside, advances in blockchain security and risk assessment models enhance the decentralised lending platform.

Flash Loans: The Innovation and Controversy

Flash loans are a decentralised finance-specific function that allows borrowing enormous amounts of cryptocurrency without collateral, provided that the loan is paid back in the same transaction. Flash loans are done using smart contracts, which automatically verify repayment terms before locking up the funds in the transaction. When the borrower is unable to repay in the transaction, the loan is reversed to prevent loss to the lender (OSL, 2025). 

Use Cases of Flash Loans

One of the major use cases is arbitrage trading, where traders exploit price differences between exchanges to achieve risk-free gain. Another use is self-liquidation, where borrowers utilise flash loans to cover debt positions and prevent liquidation charges. Flash loans also allow for collateral swaps so users can maximise loan terms by exchanging one type of collateral for another in a single transaction.

Controversies and Challenges

Though flash loans are convenient, they are a security risk. Hackers have exploited vulnerabilities in smart contracts to manipulate markets or conduct price oracle attacks, causing enormous losses. Also, market manipulation issues arise since traders can temporarily manipulate asset prices through temporary, large loans. Uncertainty in regulation also precludes the use of flash loans in traditional finance, with issues of compliance and stability emerging. 

Though flash loans bring unprecedented financial innovation, their risks necessitate stringent security protocols and regulatory requirements to prevent misuse.

Decentralised Exchanges (DEXs) and Automated Market Makers (AMMs)

Decentralised exchanges enable peer-to-peer cryptocurrency trading at the blockchain level, directly, without intermediaries. Decentralised exchanges contrast with centralised exchanges, which rely on order books where buyers and sellers match bids. Decentralised exchanges employ smart contracts and liquidity pools for automated trading (Harvey et al., 2024).

 Automated Market Makers (AMMs) are one of the technological innovations that enable decentralised exchanges to replace algorithmic pricing for the classic order books. Uni-swap (Uniswap,2020), Curve, and Balancer (Martinelli & Mushegian,2019) use AMMs to offer perpetual liquidity. Rather than direct matching of buyers and sellers, AMMs use liquidity pools where users deposit token pairs, and others trade against them. Pricing is determined by a constant product formula, such that when one asset is sold, its price rises while that of the other falls, balancing demand with supply (Mohan, 2022). 

Liquidity providers (LPs) deposit assets in these pools in exchange for transaction fees, making it profitable to do so. These, however, incur impermanent loss—a temporary loss of value compared to asset holding—when price movements prompt arbitrage. Platforms like Curve mitigate this by optimising pool compositions for stable assets (Cryptopedia Staff,2025). 

Decentralised exchanges offer benefits like security, as users maintain custody of assets, transparency through blockchain-registered transactions, and censorship resistance due to decentralisation. They also reduce trading fees by eliminating intermediaries. Challenges exist, however. Liquidity will be lower than for centralised exchanges, resulting in slippage. The user experience is complex, involving knowledge of blockchain wallets and gas fees. Furthermore, transaction speeds depend on network congestion, making trade execution slower than in centralized platforms. 

Despite these challenges, automated market makers and liquidity pools have revolutionised decentralised trading, enabling permission less access to global financial markets. As decentralised finance matures, technologies like Layer 2 scaling and improved LP incentives may further improve efficiency (Makridis et al.,2023).

 The Future of Decentralised Finance: Will It Replace Traditional Banking?

The decentralised finance market has experienced rapid growth, significantly influenced by the broader adoption of blockchain technologies and smart contracts. The global decentralised finance market is set to experience explosive growth, projected to rise from $21.3 billion in 2023 to an estimated $616.1 billion by 2033. This translates to a staggering 40% compound annual growth rate (CAGR) over the next decade, showcasing the rapid adoption of decentralised solutions worldwide. North America is a key leader in the decentralized finance market, contributing over 36% of the global revenue, which amounts to approximately $7.6 billion. (Market.us, 2024) A crucial driver of decentralised finance’s growing market demand is the economy’s increasing interest in alternative financial solutions that are more in line with the rapid digitalisation happening globally. All stakeholders of the financial ecosystem are regularly in search of ways to streamline their operations to maximise efficiency and, in turn, minimise their costs. These tie in with businesses’ objectives to profit-maximise and place the services they provide competitively, with their ever-increasing pool of competition. However, these benefits come with negative trade-offs, such as the increasing redundancy of traditional financial institutions and the need for the global population to keep up with these increasingly complex technologies. This could be an issue for the older demographic of users who lack digital literacy and trust in new technologies. Additionally, the ability to access financial services without the need for a traditional bank account makes decentralized finance particularly appealing in regions with low banking penetration. The decentralised market offers numerous opportunities for innovation and development. One of the most significant opportunities is the potential to extend financial services to unbanked and underbanked populations around the world (Market.us, 2024). In order to further develop the potential of the decentralised finance market, technological advancements, including those of their security, are vital in order to sustain a greater scale of participation in this market.

Conclusion

While decentralised finance has exciting potential to bring great benefits to the financial system as it offers innovative services with lower barriers to entry, it also carries risks, including smart contract vulnerabilities and market volatility. It is still in its infant stage and is vulnerable to hacks due to its sloppy programming and a lack of security testing before applications are launched. More needs to be done in order to strengthen the security of this market and fully realise the potential it holds.

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