Decentralized Finance (DeFi) is a leading force pioneering the next generation of blockchain innovation. Think of it as an entire ecosystem. Picture a detailed architectural drawing, with each building component – foundation, walls, beams – intricately interconnected. In the context of DeFi, those parts comprise an efficient financial system, underpinned by a decentralized, global network of liquidity providers.
How does it work?
DeFi takes the centralized plumbing of the global financial system and throws it out the window. Rather than relying on banks and other corporate institutions to provide financial services (ie, loans and high-yield savings accounts), DeFi protocols enlist the help of decentralized computer networks, funded and secured by users across the globe.
However, DeFi requires additional technology to operate – including smart contracts and DAPPS (decentralised applications).
Smart contracts, popularised particularly by the technology introduced by Ethereum Blockchain and Binance Smart Chain, are computer programmes that are predetermined to automatically execute when specific conditions are met to solidify an agreement with an informed outcome.
For example, let’s say two parties wish to initiate a life insurance policy. The terms of this agreement (payout size, beneficiaries, span of coverage) can be effectively programmed into the contract as lines of executable code. In the event that the holder of the policy were to pass away, their formal death certificate would be uploaded and execute the contract allowing payouts to be made to relatives.
Upon confirming the transaction, a smart contract will be executed and the estimated volume of currency will be purchased, providing factors such as liquidity and volatility are consistent during the brief transaction processing period.
DeFi has essentially harnessed the power of multi asset trading, traditional finance, and smart contract technology to hone an efficient and immensely powerful financial system.
Where did DeFi come from?
Contrary to traditional conventions, there is no sole creator of DeFi.
Instead it was born from various blockchain technologies that have since evolved and been usurped by more powerful ecosystems. Yet the first recorded example of DeFi in action was Rune Christensen’s MakerDAO, which provided a space for asset purchasing and holding.
Vitalik Buterin’s momentous creation of Ethereum, however, truly immortalised the role of DeFi within the crypto sphere, by providing crypto moguls the opportunity to develop their own DeFi projects on top of the blockchain – popular examples of this being BAT, OpenSea, and Uniswap.
Yet you may be curious about why a majority of these DeFi projects are not traditional cryptocurrencies – this is where DAPPS come into play.
What are DAPPS?
Just like an application on your computer or phone, DAPPS allow users to perform some sort of action, whether that be connecting with friends, buying a security, or sharing files. The key difference lies in who controls the platform. Whereas traditional, centralized applications are controlled by some type of corporate entity (ie, Twitter, Facebook), decentralized networks place power in the hands of a global network of computer operators free of institutional influence. The decentralized nature of DAPPS facilitates the creation of uncensored and immortal programs backed by cryptography.
Regardless of whether the creators have since disbanded or the project has been halted amidst development, a DAPPS programme can never be taken down and is free to use to any individual with the ability to access the blockchain.
Using backend coding that relies heavily on smart contracts, DAPPS run entirely on a decentralised network and often lean upon blockchain technology as a means of data storage. Examples of DAPPS include Brave (where BAT is the native token) and LINK (Chainlink), as they’re often ecosystems that incorporate a native cryptocurrency token to help power the application and provide a service to users.
What’s the need for DeFi?
Globally, decentralised finance provides millions of people with the opportunity to freely tap into innovative new technology and potential alternatives to traditional finance. Without the basis of DeFi, investment and spending opportunities (whether that be in a tangible or digital purchasing situation) using cryptocurrency would be impossible.
DeFi also removes the need for censorship and regulation, granting a refreshing sense of autonomy for those choosing to participate in this financial movement. Yet, like any newfound technology, there are always implications that could hinder how the future of finance integrates in general society.
A lack of regulation means that governmental control is limited and individuals can develop their own globalised financial freedom on a network interconnected with millions across the globe. However, this has been speculated by financial institutions to exacerbate current financial crime (such as money laundering) and it also exposes finances to the risk of hacking. New and powerful technologies bring trade-offs, unlocking freedoms that benefit millions and yet are ultimately fraught with inherent risks of exploitation by nefarious actors, whether hackers or money launderers.
DeFi brings back the ability to earn a meaningful yield on your deposits. Yields on treasuries and savings accounts are in the doldrums; DeFi breaks that paradigm up entirely.
Whether DeFi is something you choose to embrace or hold your reservations about, only the gradual progression of financial security and cryptocurrency integration will determine whether it eventually becomes a regulated and centralised concept or remains true to its original ethos.