What Is DeFi?
DeFi is short for decentralized finance.
Decentralized finance is another application of free, open, neutral, censorship-resistant, borderless cryptocurrency technology. It refers to ordinary financial tools/products, but built on an open, decentralized, censorship-resistant and borderless cryptocurrency, most commonly Ethereum. This would put financial products, technically, just out of reach of government and regulatory controls.
You are familiar with financial contracts such as mortgages, private loans, lines of credit, stocks, bonds, mutual funds/ETFs, insurance policies, pension plan payouts, annuities, etc. DeFi refers to smart contract programming on an open blockchain allowing for financial contracts/products between parties to occur over the live blockchain for significantly less time and cost than traditional finance now. Once a contract is written in computer code it self-executes and verifies without the need for a centralized third party (i.e. a bank, a central clearinghouse, insurance company, investment fund, etc).
Basically DeFi is the digitalization of financial contracts that eliminates most of the middlemen.
“DeFi is the idea that financial services can be 10x better than they are today. DeFi is more global, more accessible, and more transparent than traditional financial services.”Brendan Forster quoted from Matthew De Silva’s article “What’s Behind The Buzz About ‘Decentralized Finance?’“
Particularly with the proliferation of the Internet, smartphones, online banking and a progressively digital/online culture with transitioning millennials and their GenZ (sometimes called GenY) successors, it is easy to understand the mental and cultural shift to adopt faster, more cost-efficient, digitalization and decentralization of finance with cryptocurrencies. I know that as a millennial myself, I am easily frustrated by the lengthy time it takes for my bank to do some things for me, as well as for the high costs of even simply keeping a bank account open with them (and low interest I earn).
Different applications for DeFi (decentralized finance):
- Issuance Platforms/investing (i.e. stocks, bonds, ETFs, derivatives, margin trading, etc)
- Lending/borrowing protocols (private funding or public funding)
- Decentralized cryptocurrency exchanges
- Regular Stock Exchanges (i.e. NASDAQ, NYSE, TSE, London Stock Exchange, etc).
- Stablecoins (i.e. TUSD, GUSD, DAI).
- Tokenization of assets (i.e. real estate)
- Insurance policies (home, auto, life, etc)
- Asset Management Tools
Technically speaking, the first application of DeFi is Bitcoin – a decentralized network of computers, all running the same code, agreeing on the same set of mathematical rules with the function of Bitcoin tokens as a store (and transfer) of value, much like gold. Then there is Ethereum, very similar to Bitcoin in that it is a network of decentralized computers executing code with each node agreeing on a set of rules (i.e. a contract). However, Ethereum has a multifunctional use with its comparatively easier programming to create customizable smart contracts and alternate tokens on top of the Ethereum protocol. One of Ethereum’s first use cases was unregulated crowdfunding for start-ups (and scams) in 2017.
Moving forward, one of the first and most popular applications of DeFi was Maker DAO‘s DAI token, which is built on top of the Ethereum protocol. DAI is a stablecoin token, pegged to the price of the USD but backed by cryptocurrency assets such as Bitcoin and Ethereum. It is a decentralized stablecoin that can be moved anywhere in the world and used to purchase goods and services.
Another DeFi stablecoin is the much more popular Tether, or TUSD, which is tethered 1-for-1 with the USD. However, this is a centralized entity since the parent company, iFinex, custody’s fiat USD in traditional accounts, and issue digital tokens of TUSD over multiple blockchains. Tether is quite popular for moving money around the world, particularly out of China. There are questions regarding the longevity and trustworthiness of Tether since its issuing company iFinex apparently sent $850 million of USD (that is supposed to be backing the TUSD digital token) to the crypto exchange Bitfinex to cover missing funds. iFinex is also resistant to expensive third-party auditing, raising a sense of urgency to have reliable decentralized trustless stablecoins such as DAI.
Decentralized Finance Is For Everyone
The goal of decentralized finance is to level the playing field and allow anyone to act as a bank or large investment firm and invest in private debt, equity, issuance and trading of stocks, mortgages, etc. without the need of a “trusted” third party like a bank.
With DeFi you do not need to have over $1,000,000 in assets and be considered an “accredited investor” in order to invest like the best with lending products, derivatives, early-stage companies etc. Anyone with $10 and internet access will be able to invest any amount of money into decentralized products.
The goal of DeFi is to reconstruct the banking system for the whole world in the open, permissionless way.”Jeff Kauflin, “Why Everyone In Crypto Is Talking About DeFi“, Forbes
The costs and fee structures of traditional finance are prohibitively high for small investors with little capital – aka the vast majority of the world population. While there is a push from newer companies such as Robinhood and LendingClub to lower commission and withdrawal fees, it is not as low as it could be with DeFi.
By putting financial services on a blockchain, DeFi, these services can become faster, cheaper and globally accessible. DeFi, Bitcoin, Ethereum, they are all the Internet of Money.
Decentralized Finance Will Disrupt Governments’ Influence Over Money
Once DeFi is fully developed and integrates into/takes over the current/traditional financial system then finance will be much more democratic, or equitably distributed throughout the population. Anyone with Internet access (roughly 4.5 billion people) and a smartphone (roughly 4 billion people) – which is quite a large proportion of the world population (more than 50%) will be able to potentially access the same financial tools that Wall Street Bankers have.
Acknowledging that having access to the same banking services does not equate to the same amount of wealth though. Users must still understand the financial products and correctly issue them and invest their funds. Most people today simply do not want the “hassle” of investing their own funds. However, it still does help to democratize access to finance and investing, which is the starting point and could likely lead to many more self-made millionaires within the next twenty years, just as the internet did.
Moreover, governments may still issue their own fiat currencies, and those fiat currencies might be on private government blockchains. But there will be alternate options for citizens. If you do not like the government’s economic policy or inflation rate then you can move your money into a different currency system, perhaps Bitcoin or Ethereum, which are open, borderless, and censorship-resistant.
Governments will be incentivized to more responsibly utilize tax-payers dollars for two reasons: blockchains are easily auditable, so government spending of tax dollars will become significantly more transparent. And if citizens can choose to leave the country’s financial system, then the government has an incentive to keep their fiat currency valuable, and not inflate it away year by year.
Markshire Crypto Conclusion – Decentralized Finance (DeFi) Will Transform The Economy
It is not practically feasible in today’s political and economic climate to put most or all financial products/contracts on open, borderless, censorship-resistant platforms for anyone to access without AML/KYC (anti-money-laundering and Know-Your-Customer) processes. So, many projects are hybrid decentralized, typically with a central company building products on an open cryptocurrency like Ethereum, but screening users with AML/KYC for customer onboarding.
We have seen the American SEC crackdown on the thousands of unregistered security offerings that occurred during the 2017/2018 ICO (initial coin offering) market. The government will not allow any random financial product to go onto the open market, at least in America, without proper regulations.
However, slowly decentralized finance platforms will be built out. They will be more and more simple to use. One day in the next 10 years you’ll be able to build financial products as easily as you can build a website, with financial regulation laws built-in, country dependent.
So I believe that DeFi will transform finance, banking and commerce similarly to how the Internet changed snail-mail, newspapers/magazines, cable subscriptions and social interactions.
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