What is the place of DeFi in the cryptoverse? The next stage in crypto’s evolution
This year, there has been plenty of talk about DeFi in the crypto space but what is DeFi’s role in the cryptoeconomy? In this article, you will find out all about the term and how it fits into the wider blockchain universe and how it fits in the wider financial industry. In 2008, the world’s banks and financial systems crashed, resulting in a colossal amount of lost capital for many customers of particular banks. The following year, Satoshi Nakamoto invented Bitcoin, opening the gates for further cryptocurrencies and uses for coins on the blockchain.
Particularly in the last few years, the world of crypto has seen the development of many DeFi use cases on the Ethereum Blockchain, which powers the cryptocurrency ether (ETH), and thousands of decentralized applications.
What does DeFi mean? Finance reimaged by the crypto world.
DeFi, in its simplest definition, is short for Decentralised Finance. By comparison to Centralised Finance or CeFi, big banks and the worldwide financial system, it offers faster, more accessible financial solutions on blockchain rails. Based on a digital ledger which is, according to DeFi advocates, more secure, faster and could offer solutions to many problems in the banking system.
Adding to that, almost 2 billion people in the world are unbanked. That is that they don’t have access to a bank or other similar organization. However, many of them have some sort of internet access. As such, it is argued that DeFi removes these barriers to finance, free of discrimination and borderless.
Accountability is key in DeFi
While banks have regulators, there is little, besides a slap on the metaphorical wrist, that can be done to make right any wrongdoing or mistakes. This, however, is not the case with DeFi. Due to every cryptocurrency having its own ledger and, wider than that, the Blockchain ledger tracking every transaction made, accountability and traceability are easier to enforce.
While tracking transactions on a ledger, a record of everything that happens on the blockchain, can be laborious, each transaction has to be validated by nodes. Nodes, for those who aren’t aware, are computing machines designed to carry out checks and keep track of each transaction on the blockchain.
Further to this, the open-source nature of the blockchain means that everything is transparent. One of the major reasons for the 2008 financial crisis was banks making mistakes or deliberate dodgy business and covering them up. On blockchain it’s arguably easier to audit such practices. With DeFi and any other activity on the blockchain, it’s increasingly harder to hide activity without it being there for blockchain investigators and security analysts. Transparency, rather than censorship, is key to DeFi and allows for true accountability.
DeFi and Ethereum
While there is certainly room for other coins to get in on DeFi, many DeFi projects or applications currently run on Ethereum, the second largest crypto by market cap. Ethereum’s unique properties make it a great platform for these new projects and financial services to run on. As a community led project, no one person is in charge of Ethereum, giving everyone equal opportunity to utilize crypto for DeFi.
Secondly, since DeFi projects run on Ethereum, it makes it far easier to integrate and transact between DeFi, as well as combine and interact between applications. In most cases, custody of your tokens is entirely under your control, giving you complete freedom as to how you utilize Ethereum for DeFi.
DeFi is the next stage of financial services. With DeFi, at its core, being intertwined with crypto, there are always risks, however, many of these DeFi platforms use their own token to enable users to utilize the platform. DeFi’s Ethereum crypto apps proved a great opportunity to build innovative systems on the blockchain.
How does DeFi work?
So, besides being based on the blockchain, you might not know much about how DeFi works. Unlike the traditional financial system, there is no centralization, such as a bank or other institution. As such, DeFi is built on decentralized applications.
Decentralized applications or DApps utilize Ethereum or their own native coin to run. While running much like regular apps, the difference is that they run on the blockchain, using smart contracts. These smart contracts have the terms of an agreement between two sides written directly into the contract’s code which can’t be changed by anyone once on the blockchain. They can self-execute and what is written in that contract is solidified into the code of the DApp.
The future of finance
There are many applications for DeFi, not necessarily purely in the finance sector. However, there is a strong argument that while, at least for now, traditional financial institutions may remain, when Web 3.0 becomes mainstream, DeFi could have a good bite of the finance sector.
DeFi protocols like Aave allow you to earn interest on your crypto or stablecoins, borrow money on their platform and have a say in the future of the platform. However, this is just one of many ways DeFi can be of benefit to the finance sector and beyond.
Is DeFi really decentralised?
In short, the answer to this question is… kind-of. The long answer involves delving into three categories of DeFi that currently exist. So, what are the categories? Below, you will see more information regarding DeFi which is Centralised, Semi-Decentralised or Completely Decentralised.
Centralized DeFi applications such as BlockFi, Nexo and Celsius often allow you to earn based on a determined interest rate for different crypto coins and stablecoins. They will also have price feeds, allowing you to keep tabs on when may be best to buy in. There may be other uses for Centralised DeFi but primarily, it sits in a collection of apps that allow you to earn interest through staking (letting the platform lend your money to earn interest) your money.
Semi-decentralized DeFi has at least one of the following:
- Is Non-Custodial
- Price Feeds
- Interest rate determination
- Platform development
- Margin call and Margin liquidity
Some examples of platforms that are Semi-Decentralised are MakerDAO, dYdX and bZx.
Completely Decentralised platforms are what they say on the box, so to speak, or perhaps that should be ‘what they say on the blocks’? Every part of it is decentralized. There aren’t, however, any protocols or projects that fit into this category yet, however, the hope is that there will be.
Some great uses for DeFi in the financial sector could include insurance, lotteries, lending and borrowing, payments (as it was originally envisioned that crypto may be used for) and, of course, stablecoins which offer stability in the volatile DeFi world.
Why is DeFi important?
DeFi, despite its reliance on a volatile asset, shows great promise for the future in many different sectors. Primarily, as has been previously discussed, to provide all important access to financial services for the world’s unbanked population. After all, stablecoins are equal to their value in fiat currency, making them an ideal solution to solve access to DeFi equivalents to traditional financial services to those who aren’t able to access them.
This has already started happening, opening up greater opportunities to the unbanked population. The further development of DeFi and Web 3.0 will likely only provide further ways to tackle the world’s problems. Smart contracts, after all, are just instructions for a program to follow. There could be endless possibilities.
DApps: The key to DeFi’s potential
DApps or decentralised applications are a key element of DeFi and its future. The apps, much like any app, are literally just programs but on the blockchain. The nature of how these apps are built ensures accountability but also security.
Firstly, once a DApp is on the network or the blockchain, it can’t be changed. There’s also a reduced risk of hacking or changes by bad actors on the network without the network noticing. After all, every action on the blockchain is registered on a ledger, meaning that you can’t do anything without it being recorded.
Secondly, if you do try to alter anything, it is recorded in the next block’s update. The likelihood of any bad actor getting away with it without consequences is slim to none. Transparency is a great advantage to the network that allows anything to be tracked.
Finally, as long as Ethereum still exists and functions, so do the DApps and smart contracts (and Ethereum isn’t going anywhere anytime soon).
Can DeFi defy all expectations?
The potential for DeFi in all areas of life is enormous. Its greatest use is to provide financial services to those without access to them but the possibilities don’t end there. DeFi, after all, may become the basis for Web 3.0, the next standard of internet protocols, coming soon.
There is the disadvantage of the volatility of crypto, however, the separation of DeFi tokens from people’s actual finances is key here. A more transparent, inclusive system could be around the corner with DeFi, making progress where traditional financial institutions never could.