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Access to finance remains a significant barrier for Micro, Small, and Medium Enterprises (MSMEs) around the world. According to a World Bank report, about 40% of MSMEs in India cite access to finance as a major obstacle to their growth and development. Traditional banking systems often fail to meet the unique needs of these enterprises, leading to stringent credit checks, lengthy approval processes, and a lack of suitable financial products.
Given this backdrop, can there be a solution that offers MSMEs the financial support they need without the typical barriers?
Enter Decentralized Finance (DeFi) - a rapidly evolving ecosystem that leverages blockchain technology to create a decentralized, transparent, and accessible financial landscape. Small and medium enterprises (MSMEs) can access financing without the hassle of lengthy paperwork, stringent credit checks, or the need for collateral. Businesses can participate in global markets, manage their cash flow efficiently, and mitigate financial risks seamlessly. This is the promise of Decentralized Finance (DeFi), a rapidly evolving ecosystem that is revolutionizing the way we think about financial services.
DeFi, or Decentralized Finance, is a financial ecosystem built on blockchain technology that operates without the need for traditional intermediaries like banks. Unlike the centralized financial systems, where intermediaries control access and facilitate transactions, DeFi operates on a peer-to-peer basis, using smart contracts to automate and execute transactions.
Smart contracts are self-executing contracts stored on the blockchain. They are used to automate and execute financial transactions without the need for human intervention. Much like the vending machine that will only dispense your desired product after all requirements are met. If you don't select a product or insert enough money, the vending machine won't give out your product.
Traditional financial systems rely on a set of intermediaries such as banks, brokers, and exchanges connected by payment systems. These intermediaries serve as centralized actors that guard access to the financial system and provide customers with essential services such as record keeping, verification of transactions, settlement, liquidity, and security. They help with implementing regulatory goals such as tax reporting, anti-money-laundering laws, or consumer financial protection.
The intermediaries can hold significant power based on their preferential access to customers and data. This centralized position, if not properly harnessed and regulated, can lead to considerable inefficiencies, fragility, and systemic risk if core intermediaries become corrupted or investors lose trust in the system.
A decentralized financial system is not controlled by any central authority. It offers the possibility of a completely different financial architecture, commonly called decentralized finance (DeFi), where record keeping is decentralized, access to the system is anonymous and unrestricted, and any form of intermediation would be built on top of it. Instead, it is governed by a network of computers in a distributed ledger (blockchain) that runs smart contracts.
DeFi applications and protocols are built on top of blockchains, such as Ethereum and Polygon. Blockchains are distributed ledgers that record all transactions in a tamper-proof manner. This makes them ideal for financial applications, as they provide a secure and transparent way to track and execute transactions.
The protocol layer supplies standards for specific use cases such as decentralized exchanges, debt markets, derivatives, and on-chain asset management. These standards are usually implemented as a set of smart contracts and can be accessed by any user (or DeFi application). To use DeFi, users need to connect their cryptocurrency wallets to DeFi applications or protocols.
Once connected, they can access a wide range of financial services, including:
DeFi offers several benefits over traditional financial systems, including:
While DeFi offers several benefits, there are also some challenges that need to be addressed, including:
With the help of the community and without the need to turn to a bank or non-banking financial company, MSMEs can meet their capital requirements thanks to decentralized community finance. Generating demand in advance guarantees MSMEs that lenders will visit their establishments. Less bureaucracy results in fewer loan defaults because MSMEs are now businesses that people often deal with directly.
According to a 2021, WEF report on Decentralised Finance, some businesses use payment companies like BitPesa in Africa, Tranglo in ASEAN and the major DeFi exchanges to either make direct payments or convert payment amounts to USD-backed stablecoin for cross-border remittance.
BitPesa in Africa, drastically reduced transaction costs for cross-border payments with DeFi. With approximately 6,000 users, in 2017 Bitpesa has generated an estimated $10,000,000 in trade volume per month in 4 of the 7 countries it currently operates. By using DeFi, BitPesa has decreased transaction costs by up to 75%, enabling more businesses to engage in international trade.
In both Indian and international markets, DeFi (Decentralized Finance) offers a transformative opportunity for MSMEs by providing access to financial services that are typically difficult to obtain through traditional banking channels:
Indian MSMEs should begin by educating themselves about DeFi (Decentralized Finance) and its potential benefits. Partnering with fintech companies or consultants who specialize in DeFi can provide tailored guidance and help MSMEs navigate the complexities of this emerging field. In 2024, MSMEs should take the following steps to access DeFi:
By taking these steps, Indian MSMEs can start integrating DeFi into their operations, gaining access to new financial opportunities and positioning themselves at the forefront of financial innovation.
Decentralized Finance (DeFi) is bringing intriguing options and transforming the financial sector, utilizing its advantages, such as financial inclusion, global reach, lower costs, and improved security. For MSMEs, both in India and internationally, DeFi can unlock new opportunities for growth, innovation, and financial stability. However, to ensure the success and sustainability of DeFi solutions, it is crucial to address regulatory hurdles, security issues, and user education. Adopting DeFi means shaping the direction of finance itself, not just remaining current.
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