Open Finance & Decentralized Finance – Learn Better

Digitalization has become even more popular and digital services are more widely used than ever, especially in the financial sector. Thus, by integrating the conveniences of the online world into the financial world, users are provided with the most reliable and higher-quality services. The banking sector, which is an area that cannot be separated from the finance sector, can also benefit from different features of technology and revolutionary innovations: Open Finance and Decentralized Finance. In this article, we will talk about both of them.

KEY TAKEAWAYS:

• Open finance allows users’ data to be shared by reliable third parties to provide better banking and finance opportunities.
• The UK is the first country to apply the open finance system to its financial structure.
• DeFi allows individuals to perform peer-to-peer transactions with no central control mechanism requirement. 
• DEXs are exchanges where individuals can buy and sell coins only by a wallet address, without sharing their personal information with a center or relying on authority for fund protection.   

What Is Open Finance?

Open Finance, or Open Bank Data, is a reliable and novel service model in which an individual’s financial data is shared with third parties to provide better banking and finance opportunities. This financial data is shared with the user’s consent; only the data you request is shared with other third organizations, thus protecting the user’s privacy rights considering the data sharing procedure.

FUN FACT

Before the PSD2 directive was published in the European Parliament, there was no official implementation of open finance. After 2015, the number of consumers benefiting from open finance services increased rapidly after the directive was adopted in order to make payments in an innovative, digitalized, and secure manner.

In addition to banking services, open finance offers all services such as insurance, wealth management, asset management, unsecured lending, mortgages, and pensions. It is estimated that the users who will benefit from all these services will reach 132.2 million by 2024. The data collected through the services provided are used in the healthcare, retail, city, transit, utility, and telco sectors.

The Importance of Open Finance 

One of the things that companies, governments, and organizations value most in the modern world is data. This is because, with data for a group, community, or user type, it’s easier to make plans. For example, data means producing algorithms that predict content that users will like in the internet world. But what could accurate data mean in the financial industry?

Data in the financial industry is valuable in enabling consumers and businesses to understand their spending and saving behaviors. To put it this a nutshell, data in banking can be used to produce the most efficient financial habits for users. 

Open finance allows third-party services to gather data from various financial institutions and analyze users’ financial habits to create a better budget plan, considering future spending. Through financial services, open finance can offer better service recommendations, such as a more suitable credit card or budget planning with a better interest rate, and thus enable the entire financial sector to work better, faster, and more effectively. 

Let’s list some of the opportunities promoted by open finance:

• Offering new business types 
• Products and services where the user is centered
• Increased customer confidence
• Digital improvement in the financial industry 

How Open Finance Entered Our Lives: From Open Banking

This model was first implemented in the UK in 2016 to provide competition and diversity of opportunities by providing an innovative perspective to the UK’s banking sector, which makes the UK the first country in the world to switch to the Open Banking Model. In 2016, the British Competition and Markets Authority (CMA) gathered major banks and enterprises licensed by the government under the Open Banking Implementation Entity (OBIE).

However, in 2015, Open Banking plans had already been made by the institutions responsible for the European Union’s financial regulations. Therefore, a new financial strategy would enable third-party institutions to access financial data and improve user experience.

Nevertheless, it should be underlined that the concept of open banking and a more comprehensive open finance have some differences. Here are the differences:

5 Main Advantages of Open Finance System

Let’s have a look at five important potential advantages of open finance system: 

1. API Utilization: Open Finance allows functional and data-driven APIs. APIs are a very useful technology that includes transferring money and simultaneous viewing of movements of different accounts to facilitate and make financial-based services more effective. These APIs, which are the most practical innovations that open banking has contributed, enable users to manage their financial resources through only a single app that combines different features. Moreover, open banking allows third-party organizations to access your data, offering you suitable services that can meet the public’s needs.
2. More Detailed Consumer Profiles: Open Finance does not use data that can only be collected by the bank when drawing a consumer’s profile. Instead, it helps to make a credit score calculation that better reflects the reality by examining the broader behavioral habits of the consumer.
3. Service Optimization: Open finance offers more data that can be processed in order to predict which services consumers need, optimize existing services, and guide the user during service purchase.
4. Tailor-Made Services: In today’s world where personal data privacy is more important than ever, the data shared in the open finance system depends only on the consent of the user. What is expected is that the user prefers to share their data in order to see the optimized and tailor-made services.
5. All-in-One Finance Services: Instead of dispersing financial services among institutions and prolonging paperwork and bureaucratic processes, imagine that they are all consolidated into a single center. This is the ultimate goal of Open Finance. The convergence of institutions that are aware of the data they collect, the money they process, and the services they provide at a central point. Thus, saving time and energy for both consumers and service providers.

Disadvantages of Open Finance

But, of course, open finance is not Alice in wonderland, and it has some downsides. 

1. Indirect Obligation to Share: The biggest disadvantage of these is that users do not support sharing their information with third parties no matter what is said, which causes low customer credibility. 
2. Data Security: User data that is collected and shared with many institutions in order to provide a centralized financial services formation may not be truly secure. In particular, the fact that all of the digitally collected data is accessible from a single point will mean that a single vulnerability will enable access to a database that is sufficiently detailed to be dangerous. This is a real opportunity for scammers.
3. Negative Public Perception: Although it is an advantageous method for service providers in practice, the public’s anxious attitude about sharing their personal data can make open finance far from being viable. For example, research shows that 26 percent of people are not willing to share any of their data with banks. Here is some surprising data: It is possible to say that 63 percent of users have not even heard of open banking yet.

Then What is Decentralized Finance?

The production of cryptocurrencies and tokens has led to an increase in financial services that operate completely decentralized and are built on the blockchain network. Thanks to DeFi with peer-to-peer blockchain technology, individuals can transfer, borrow, lend, and stake assets online without the need for a third regulator or a central financial institution. The famous manifesto published by Satoshi Nakamato in 2009 and the rapid production of other altcoins and tokens after Bitcoin created diversity in the types of assets that can be used in these decentralized financial services.

What Defi Offers

Today, it offers many cryptocurrencies and tokens, decentralized wallets, a change of generating interest income with staking, yield farming, peer-to-peer borrowing and lending services. Moreover, this decençtralized technology has allowed the development of DEX platforms where users can exchange assets.

Usage of Smart Contracts

Like any financial structure, DeFi must have an element of trust. For this reason, the DeFi structure is secured with formulas that are very difficult to compromise: smart contracts. Smart contracts ensure the security of users by determining the conditions that must occur in the process of transacting in any project and making the transaction process dependent on these conditions. All the details in a network, from the interest rewards from staking to the transaction fee, are determined by smart contracts. Care and attention in the process of creating these contracts make the network and DEX services more reliable.

DEXs: The Children of DeFi

There is a question you can ask at this point. But what is a decentralized exchange? All right, you’re right. Let’s answer right away! Decentralized exchanges are completely open-source exchanges that do not depend on any authority and allow peer-to-peer transactions without the need for a third party. All the information on a DEX is open to public surveillance.

Decentralized exchanges, as DeFi, do not require a regulator team after the system is coded. The stock market can function automatically. After a DEX is completely constructed, individuals can make P2P trades, which are completely transparent.

The security of exchanges is provided by distributed ledger technology (DLT). DLT, with its shortest definition, all transactions and information about these transactions can be observed, accessed, and verified by everyone. However, the information only contains the technical details of the transaction. All required as a piece of information is the wallet address. 

Sidenote: You can check all the DEXs from here with some additional information such as volume and type.

Peer-to-Peer Transactions Through DeFi

The biggest innovation coming with DeFi is that individuals can trade their digital assets with each other without the need for a major central intermediary like a bank or let’s say, PayPal. However, the problem with these third parties is that they are financial structures dependent on a central or authority. In other words, these transactions you will do are under someone’s control, which you cannot freely do.

The Importance Of DeFi: What It Adds to Finance World

DeFi allows people who do not trust the traditional financial system to perform financial transactions not by a regulator but through an algorithm to which millions of devices are connected. Users of the system maintain the DeFi network through a consensus. Thus, no center can singlehandedly regulate the whole DeFi system. 

Important aspects of DeFi systems in general are:

• It paves the way for decentralized exchanges, decentralized applications (DApps), and decentralized autonomous organizations (DAO).
• It has developed the token system while offering different collateral and financing alternatives.
• It provides the opportunity to perform internal and external trade transactions in a decentralized, fast, and transparent manner.
• It enables the money-based banking system to be used by anyone all over the world.
• As we mentioned above, it allows users to borrow and lend money without the need for a third intermediary.
• It enables new cryptocurrencies to enter the market and raise funds for projects for Initial Coin Offering (ICO).
• It has contributed to the decentralized digital identity technology.

What Do DeFi Apps Offer People? 

Users can utilize DeFi via decentralized applications based on the Ethereum blockchain. Unlike traditional banks, decentralized applications demand no application form or an account.

Here below, we have prepared a table including how individuals benefit from the DeFi Technology

What Are The Differences Between Open Finance and Decentralized Finance?

Open Finance aims at a future where banks and financial institutions want to expand their service portfolio. The data that comes together and provides a better interpretation of the behavior and habits of the users can be seen by the banks involved in the system and third parties providing financial services. However, subjects outside the system do not have access to these collected data. Databases store customers’ data with a centralized system in order to protect their confidentiality.

1. The main difference between DeFi and Open Finance is that DeFi does not require a central authority to provide financial transactions, services, or traded assets. Everything is done with smart contracts. Open Finance, on the other hand, is fully decentralized, only the customer data collected can be accessed by a centralized group of institutions.
2. What Open Finans does is enable existing financial institutions and banks to have easier access to customer data and to expand the service portfolio of institutions. DeFi, on the other hand, proposes a completely new banking and financial system: There are no bureaucratic steps or monopolized banks in this system.
3. Open Finance aims to eliminate the period of going to different institutions for the different financial services you receive: Because your consumption data is gathered not only to understand your behavior but also to make the management of the services you purchase possible from a single place. In DeFi, on the other hand, accessible data does not refer to a monopolized set of services, but rather decentralized services that are distributed across an ecosystem.

What Are The Problems Of Centralized Finance?

To understand better what the DeFi system can solve, we should focus on the problems branched out from centralized finance. Let’s make a comparison between DeFi and DEX to depict the real issues of centralized finance.