Decentralized finance (DEFI): the next frontier of banking with blockchain and AI

Аннотация

Decentralized Finance (DeFi) represents a groundbreaking shift in the banking sector, transforming how financial services are accessed and managed through blockchain and AI technologies. This paper explores the foundation of DeFi, powered by blockchain and enhanced by AI, and its implications for the future of finance. We discuss the advantages and challenges of DeFi, envisioning a future where finance is decentralized, transparent, and more accessible than ever. Keywords: Decentralized Finance, Blockchain, AI, DeFi, Smart Contracts, Financial Technology, Banking Introduction: The Rise of DeFi Decentralized finance (DeFi) is transforming the financial sector by removing traditional intermediaries like banks and institutions, and replacing them with blockchain technology. This shift allows for direct peer-to-peer transactions, offering greater transparency, lower fees, and increased accessibility, especially for those without access to traditional banking. DeFi is built on the principles of decentralization, security, and transparency, facilitated by smart contracts—self-executing contracts coded to automatically enforce terms without a middleman. While the concept has existed for some time, it was Ethereum’s introduction of smart contracts in 2015 that truly unleashed the potential of DeFi. Today, DeFi continues to grow rapidly, driven by blockchain and AI technologies, promising a more inclusive and efficient financial system. However, challenges like security vulnerabilities and regulatory uncertainty remain, which this article will explore, along with the role of developers in advancing DeFi. 84 “Raqamli iqtisodiyot va sun’iy intellekt texnologiyalarining jamiyat rivojlanishidagi ahamiyati” mavzusidagi xalqaro ilmiy-amaliy konferensiya 2024-yil 22-noyabr, Tоshkеnt, O‘zbekiston Traditional banking vs. blockchain infographic. Blockchain as the Foundation of DeFi Blockchain technology is the backbone of DeFi, providing a decentralized ledger that ensures the transparency, security, and immutability of transactions. In a traditional financial system, banks and other institutions act as trusted intermediaries, verifying and recording transactions. Blockchain, on the other hand, eliminates these intermediaries by using a distributed network of computers (nodes) to validate and record transactions in a secure, transparent, and decentralized manner. Each transaction on a blockchain is recorded in a “block,” which is then linked to the previous block, creating a chain. This chain of blocks is immutable, meaning once a transaction is recorded, it cannot be altered or tampered with, providing a high level of security and trust. The decentralized nature of blockchain means no single entity controls the network, making it resistant to censorship or manipulation. One of the most significant contributions of blockchain to DeFi is the introduction of smart contracts. Smart contracts are self-executing contracts with the terms of the agreement directly written into code. When predefined conditions are met, the contract automatically executes the transaction without the need for intermediaries. This feature eliminates the need for trusted third parties and reduces the costs and time associated with traditional financial services like lending, borrowing, and trading. Blockchain also enables the creation of decentralized applications (dApps), which are built on the blockchain to offer financial services such as insurance, lending platforms, and decentralized exchanges (DEXs). These dApps are powered by the blockchain’s security and transparency, allowing users to trust that the services they are using operate without central authority oversight. 85 “Raqamli iqtisodiyot va sun’iy intellekt texnologiyalarining jamiyat rivojlanishidagi ahamiyati” mavzusidagi xalqaro ilmiy-amaliy konferensiya 2024-yil 22-noyabr, Tоshkеnt, O‘zbekiston DeFi common mechanism and revenue strategy. o Protocol: A collection of smart contracts encompassing various facets like PLFs, AMMs, or yield aggregators. These protocols offer open, noncustodial, permissionless, and composable financial services in exchange for nominal fees levied on asset movements, such as borrowing or swapping. o Investor: This participant assumes the underlying protocol risk, including potential misbehavior, impermanent loss, or rug-pulls, in return for passive income. Their primary role involves depositing assets and providing liquidity to these financial services. o User: Typically, users interact with the protocol in real time, not expecting extended responses. However, in the case of yield aggregators, users may also function as investors. Users initiate asset movements and pay interest rates to the protocol. o Financial Service: The linchpin of the entire protocol, this entity locks assets, fulfills asset movement requests, and safeguards against protocol misuse. Additionally, it can act as an investor by leveraging other DeFi protocols, ultimately delivering yields and e