Decentralized finance—often called DeFi—refers to the shift from traditional, centralized financial systems to peer-to-peer finance enabled by decentralized technologies built on the Ethereum blockchain. From lending and borrowing platforms to stablecoins and tokenized BTC, the DeFi ecosystem has launched an expansive network of integrated protocols and financial instruments. Now with billions of dollars worth of value locked in Ethereum smart contracts, decentralized finance has emerged as the most active sector in the blockchain space, with a wide range of use cases for individuals, developers, and institutions.
Whereas our traditional financial system runs on centralized infrastructure that is managed by central authorities, institutions, and intermediaries, decentralized finance is powered by code that is running on the decentralized infrastructure of the Ethereum blockchain. By deploying immutable smart contracts on Ethereum, DeFi developers can launch financial protocols and platforms that run exactly as programmed and that are available to anyone with an Internet connection. bitcoin vs gold
The breakthrough of DeFi is that crypto assets can now be put to use in ways not possible with fiat or “real world” assets. Decentralized exchanges, synthetic assets, and flash loans are completely novel applications that can only exist on blockchains. This paradigm shift in financial infrastructure presents a number of advantages with regard to risk, trust, and opportunity.
To illustrate what DEFI is (and what it definitely is not!) Let’s use a simple example. You want to pay your friend who is a baker for some sourdough bread, they offer you the opportunity to pay with your debit card via iZettle, so you tap your debit card to the terminal. The process of transferring money between you and your friend needs your bank, your friend’s bank, a payment network (like VISA or Mastercard), and the terminal/gateway provider. This is NOT DEFI. The delivery mechanisms, in this case, are all centralized (and there are many of them).
A decentralized version of the same transaction would see your digital wallet interacting with your friend’s digital wallet directly and the transaction then being verified on a distributed ledger that is not owned by one company or organization. A peer-to-peer payment is really the most basic example to describe DEFI, however, with the use of smart contracts, DEFI projects are diversifying into evermore complicated areas of finance from lending to trading, savings to insurance… and more. Many centralized financial systems are antiquated and slow… ever tried to send money to another country or drawn down from stocks and shares ISA? There is no technological reason that these transactions shouldn’t occur within milliseconds, but they can take anything from 2-5 days. crypto trading signals best penny cryptocurrency to invest in 2021
But it isn’t just pace and modernity that can be the justification for DEFI, think about security. Centralized systems (especially antiquated ones) can be vulnerable to a new generation of nefarious hackers. Reputable financial institutions and their centralized systems can be vulnerable to data breaches, fraud and security issues. And it is customers who initially suffer in these security breach situations, by being locked out of their apps, their digital banking and being reissued cards. DEFI aims to address the three-pronged problem within crypto finance of Scale, Pace, and Security, all whilst remaining completely decentralized.
Current State of DEFI
DEFI aims to be fast, secure, cheap, available, connected and egalitarian. Sounds great! Let’s look at a few of the best DEFI’s in the space.
Who is doing what?
To explore the world of DEFI projects, let’s take a look at three separate categories. First – the enabler, second – the lender and third – the interest rate protocol.
The Enabler – Algorand
Algorand is a platform to build DEFI projects on. Their aim is to remove the technical barriers which have impeded blockchain and decentralised ledger projects to date. Their objectives are to facilitate bringing new financial assets on chain, building new tools & services and expanding the methods for transaction and exchange of value. With a Turing award winner as their founder and employees who moved from IBM, Google & Mozilla with their Ivy league & MIT credentials in tow, they are a serious outfit that wants to enable enterprises to embrace decentralised finance.
The Lender – AAVE
AAVE has taken a financial instrument called Flash Loans to market, which is the first uncollateralized loan option in the DEFI space. Designed for developers, AAVE’s loans allow a developer to borrow any available amount of digital assets without putting up any collateral, as long as the liquidity is returned to the protocol within one block transaction. This high technical knowledge transaction is an example of how the mechanism of lending and the stipulations that guarantee the safety of the funds in the reserve pool (and the complexity of the necessary contracts) can be disrupted with DEFI.
The Interest Rate Protocol – Compound
Compound Labs is an open-source software development company that builds products and services for DEFI. The compound protocol means that any individual who holds cryptocurrencies can earn interest in the same way that someone with pounds sterling in their savings account can. This algorithmic, autonomous interest rate protocol can be utilised by platforms or wallets to incentivise the secure storage of digital assets by their customers. However, this could be applied to any central bank issued stable coins that are created in the future.
Compound aims to maintain, manage and audit a publicly verifiable and secure interest rate protocol that leverages smart contracts to provide safe and stable earnings on digital assets. so, as you can see, it’s pretty tech heavy stuff. But as with fintech’s, the ‘bet’ is that technologists can develop better systems, processes, methodologies and delivery mechanisms outside of the large (and in some cases slow) financial services organisations, and then help these same established financial services providers disrupt their business models, by incorporating the best of what has already been developed, tested and proven.
The Future of DEFI
Based on what we know, what is already in progress and what is being worked on, The future of DEFI might look like this:
- Speed and Reduced Network Fees. With the transition to proof of stake on Ethereum and continued advancement of layer 2 solutions, we should see Ethereum defined network fees dramatically dropped to fractions of a penny per transaction. While transaction throughput increases to the point where you can confirm transactions within a few hundred milliseconds, the length of time required to click a button on the screen.
- Liquidity. Liquidity will continue to grow on AMMS indexes to the point where you can trade hundreds of millions and Eventually billions of dollars in a single transaction with near zero slippage. Total Value Locked or TVL across all of DEFI will grow to easily eclipse the market cap of bitcoin and given that DEFI and Ethereum will likely hold more than 50 percent of the circulating bitcoin supply in the form of tokenized BTC like RENBTC or SBTC. If BTC keeps going up in value, how can any bitcoin HODLER skip the opportunity to passively earn with their BTC, especially when there’s no KYC or sign up required?
- Trading. DEFI, like synthetix, will someday allow you to trade pretty much whatever you want. Forex markets, commodities like gold, oil or google, stock, the S&P 500 index , Tesla stock, you name it. Derivatives trading in DEFI on Ethereum will be a multi-trillion dollar market and not only will we witness these sort of numbers but This trading will eclipse the volumes traded currently because what trader would ever want to trade on markets during limited business hours, where they can trade 24×7, 365 on the crypto market. Basically, meaning there is money to be made anywhere at any time.
- Celebrity Tokens. The biggest artists, musicians and athletes in the world will turn to issuing personal tokens to better connect with their fan base by rewarding them with tokens that represent their influence. Kanye West might well introduce a Yeezy token; the next Michael Jordan will have an air token in it. Literally anything can happen.
- Mortgages. DEFI will eventually erode some of the most sacred institutions of finance such as home mortgages. Once DEFI establishes a reliable, under collateralized lending it’s lights out! Now why would anyone turn to manually emailing all their personal information with a dozen middlemen involved each charging a fee when home buyers can easily get instantly approved for the money they need to purchase a home on the likes of AAVE or COMPOUND.
It may sound like fantasy but this is really just around the corner and the list goes on. The point is that we as humans are terribly flawed at estimating the exponential changes that come about from technology and this is a yet another example that we will likely all look back upon to say “I just didn’t understand what was coming… I couldn’t see it well…” I don’t blame you.
- DEFI – Is The Future Of Finance Decentralised? – https://consensys.net/blockchain-use-cases/decentralized-finance/
Current State of DEFI – https://www.finextra.com/blogposting/19929/DEFI—is-the-future-of-finance-decentralised