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What is DeFi (Decentralized Finance)?

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An illustration of a government building in front of a purple square with crypto logos around it to depict the topic of what is decentralized finance

The world of cryptocurrencies is expanding at such a rapid rate. Who would have thought the merging of cryptography and distributed ledger technology would give birth to an industry that revolutionized the way we perceive money, store value, and transact?

With the invention of cryptocurrencies, finance becomes decentralised. A whole new industry was born — the Decentralised Finance industry (also known as DeFi).

So, what is decentralized finance?

To put things simply, DeFi is a union between traditional banking services with decentralised technologies such as cryptocurrencies and decentralised applications (or DApps).

Technically speaking, decentralised finance (DeFi) refers to a merger of all the decentralised products and services. For example, crypto assets, smart contracts, protocols and applications. 

In order to get a better understanding of what is decentralised finance, I’ll try to break this down a little further by comparing this to traditional financial systems. 

Comparing DeFi with traditional or ‘legacy’ finance

At the moment in the conventional economic system, we have a central authority that is at the core of our financial system (e.g. the government or central bank).

The current financial system requires its users to rely on a middleman to maintain the value of their currency, to take care of the deposited money and even intervenes in how transactions are carried out.  But with DeFi, this does not have to be the case.

DeFi can also be seen as an Open Finance Movement that enables money and payments to be universally accessible – to anyone in the world, no matter where they are.

Imagine a global, open, alternative to every financial service you’re currently engaging in —  savings, loans, insurances and more. All you need is to be connected to the internet, and DeFi is powering ahead to materialise this. 

Difference between DeFi and traditional financial services

DeFi honors the principle of decentralisation. This means that DeFi protocols or apps require for its code to be transparent on the blockchain so that anyone is able to carry out an audit.

This paves the way for a different kind of trust with participants because anyone has the opportunity to understand how a contract works or even to find potential bugs.

Image of digital tablet displaying a financial graph
Programmers can now become financial auditors, who would have thought?

Transaction activities are open for the public’s review —  yes, that includes you and me. Although some people are concerned about privacy issues, rest assured as transactions are pseudo-anonymous. 

DeFi protocols or applications are not fully managed by a single entity, its developer, or its employees. Instead, rules are typically written in code or smart contracts.

Once the smart contract is deployed onto the blockchain, applications are able to run on their own without further intervention. The only time when developers are involved is when upgrades are needed or to carry out maintenance such as bug fixes. 

What are the benefits of DeFi?

  • DeFi apps are designed for a global audience. Anyone from around the world can participate in DeFi platforms. All you really need is a smartphone with internet access. DeFi also offers programmability. Perhaps the most exciting potential of the DeFi movement is its ability to provide financial services for those who do not have access to traditional banking facilities. The current banking system leaves around 31 percent of the global population without any form of banking.
  • Immutability. This means that data coordination across the blockchain is tamper-proof and this increases security and auditability.
  • Interoperability. Since Ethereum’s software stack is composable, DeFi protocols and applications are built to be integrative and complementary to one another. This means that those involved in DeFi have the flexibility to build on top of other existing protocols, or to integrate other third-party applications. Think about DeFi as some sort of “money legos”.

To be honest, the list goes on and on when it comes to DeFi’s benefit. And other perks include DeFi being permissionless, and enabling self-custody. 

Should you invest in DeFi?

Well, like any other investment, DeFi too, has its risks. In fact, because it is such a young market, the DeFi market does perhaps have a larger degree of risks. However, many believe that DeFi is the future of finance and DeFi has a lot to offer in how we make purchases and settlements. 

Perhaps the biggest risk is that most newcomers to the DeFi space are unable to differentiate between a good project from a bad one. Not all DeFi projects succeed, in fact, many do fail. And there are plenty of bad ones (read: a scam).

A project called ‘YAM’ crashed and burned where its USD 60 million market capitalization went to zero dollars in the short span of 35 minutes. Other DeFi projects that led investors to bleed include Hotdog and Pizza. Yes, the risk is real. 

A cluttered desk with a woman on one side pointing to someone off the frame
DeFi can pave the way for new work opportunities.

But to be fair, there are also successful DeFi tokens, such as YIFI from Yearn.Finance. What appears to be a trend is that as technology disrupts how we do our banking, there is a growing prominence of the role DeFi can play. 

And it would not be too crazy to imagine a world where decentralised applications will set the new standard for future financial services. 

What are my thoughts on DeFi?

I am a late bloomer when it comes to learning about decentralised finance, or more commonly referred to as DeFi.

It was only when I came across Pantera Capital’s CEO, Dan Morehead’s explanation of why DeFi has more chances to grow 100x in the next five years than Bitcoin when I made it a point to dive deep into the DeFi rabbit hole. 

To conclude, we come back to the question of what is decentralized finance, and what can we expect in the future? One thing for sure is that DeFi is spearheading the way we perceive and interact with day to day financial services.

It has the potential to pave the way for a more open financial system; one that could be inclusive. Despite the financial havoc resulting from COVID-19, many DeFi token have surged in value, with some of the stronger projects surging by 200 percent since the beginning of the year.

Personally, I am interested in what the DeFi movement proposes – to give economic power back to the people by creating a financial system that is inclusive, accessible, and transparent.

Maybe DeFi is just the catalyst we need to give birth to a truly global financial revolution. In any case, what are your thoughts on decentralized finance?

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Last updated on 8 June 2021.

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