What is DeFi? The Financial Revolution Everyone’s Talking AboutLaura
In late 2017, the cryptocurrency world was freshly oxygenated by a novel concept known as decentralized finance (DeFi). Developers and investors in the crypto community were excited about the prospect of using the underlying technology powering digital currencies to recreate the entire financial system from the ground up.
Now, in 2021, this reality seems within reach. Developers and early adopters are excited about the prospect of creating a fairer, more accessible and more secure financial system for the global economy.
Here’s what you need to know about this revolutionary concept.
What is DeFi?
Put simply, DeFi is the concept of replicating traditional financial instruments in a decentralized architecture. In other words, using blockchain technology to recreate securities and systems that are commonplace in the traditional banking sector. According to Coinbase, this is now possible through the execution of smart contracts, which enable developers to build far more sophisticated functionalities than simply sending and receiving cryptocurrency. This is achieved through decentralized apps, or Dapps.
Compound is a Dapp which is a great example of this. It uses blockchain technology to recreate the traditional money market fund. Compound users can deposit their assets on the platform and earn interest. Putting Ether in Compound currently delivers a 0.67% net return. Users can also use the platform to borrow ETH at rates as low as 2.61%.
Unlike a typical money market fund, Compound isn’t controlled by a central entity. Dapps like Compound have increased efficiency and transparency which optimizes returns because traditional middlemen are eliminated.
It’s also important to note that the total value currently locked in DeFi has skyrocketed over the last 90 days. DeFi Pulse states that in 2020, the value of DeFi was under 1 billion – now it’s reached approximately 26 billion USD.
What’s the difference between DeFi dapps from Wall Street counterparts?
The main difference is that Dapps are open to everyone, everywhere. Everyone can access DeFi networks with an internet connection, notwithstanding local regulations.
The operation of businesses using DeFi aren’t managed by institutions but rather written and embedded in executable code through smart contracts.
Smart contracts are programs running on blockchain that can execute automatically when certain conditions are met. An advantage of smart contracts is that the code is publicly available for others to audit. Users can also see transactions and all activity is public for anyone to view.
Lastly, DeFi applications are embracing interoperability – and can be built through the combination of other DeFi products like decentralized exchanges, stablecoins etc. These can be combined to form new products and services, addressing various use cases.
What does DeFi solve?
DeFi applications solve the same problems for crypto users as the traditional financial institutions solve for the fiat-based economy. The way banks, brokerages and stock exchanges help people access fiat capital, DeFi enables users to access digital capital.
Developers have already launched decentralized exchanges (DEXs) that enable users to trade digital assets, stablecoins that serve as a proxy for fiat-currencies, lending platforms to help entrepreneurs and investors borrow money, and prediction markets to allow users to bet on real-world events. One of the most well-known DEX’s is Uniswap – a decentralized trading protocol with guaranteed liquidity for millions of users.
However, there is one key difference: decentralization. The fact that there is no entity that exerts complete control over the system makes the system more reliable, secure and trustworthy. An example of how centralized systems can change the rules and put users at a disadvantage unfolded last week when Robinhood prevented its users from buying certain stocks but allowed them to sell it. Many of Robinhood’s rivals also implemented these rules on short-notice, erasing billions in value for investors overnight.
How does this impact crypto?
DeFi adds features and liquidity to the crypto community, which ultimately makes crypto assets more valuable. We believe that bitcoin and DeFi assets are the perfect match and are complementary to each other. Furthermore, proof-of-work and proof-of-stake DeFi smart contracts are the keys that will unlock blockchain’s full potential.
Decentralized systems may also gain favour as more people recognize the vulnerabilities and inherent unfairness in the traditional financial system. Ultimately, this should help more people adopt the technology and drive the market prices of these cryptocurrencies higher over the long-run.