Decentralized Finance takes the financial industry and places it on the blockchain. Called Defi for short, it is an area within the blockchain ecosystem that is showing a lot of growth and a lot of developer activity.
DeFi builds on the crypto-spirit that was born when Bitcoin was launched in 2009. The goal of Bitcoin was to create a more fair and more equitable monetary system. A decade into Bitcoin, nobody can argue it has not been a success. However, DeFi takes it to the next level.
DeFi is an umbrella term that includes all types of financial products that exist as smart-contracts on the blockchain.
Smart-contracts are digital agreements written in code, that automatically execute, and exist on the blockchain. The potential for smart-contracts is massive, because any asset can be digitized on the blockchain. Imagine the title for a house is on the blockchain. The smart-contract will transfer the title of the house when it is sold, only after the sale is complete and payment is received. Learn more about smart contracts.
Traditional Financial products are all run by centralized businesses, meaning they are owned, operated, and controlled by the owners of the company. To invest in these companies, you need lots of available capital, and the company has to accept your investment. With DeFi, you can start investing by providing liquidity in any amount, no matter how much money you have.
The idea is to open up finance, putting the protocols into the hands of the people, make it fair and make it accessible to everyone. There are no middle-mans or gatekeepers. Make no mistake, this is the future.
The majority of DeFi activity happens on Ethereum
Ethereum is the 2nd largest cryptocurrency and has the most developer activity. To understand why Ethereum is the platform of choice for DeFi, let’s take a look at some features of the Ethereum blockchain:
- Smart Contracts – Smart Contracts are used to automate actions and decision making based on events. The smart contract is written in code and lives on the blockchain.
- Tokens – developers have freedom to create tokens. Tokens are cryptocurrencies that live on the Ethereum blockchain. Ethereum provides the infrastructure for projects to build on.
- Self-Governance – Ethereum blockchains provides for the ability to create DAO’s – decentralized autonomous organizations. This provides the opportunity for anyone to become a part of the ‘board of directors’. You cast your vote for the direction the dapp is heading.
What kind of financial products exist in DeFi?
- Decentralized Exchanges – DEX for short, there operate as platforms where users can trade assets – just like the stock exchange. Some are very advanced in nature, and some are setup for instant swapping of tokens.
- Lending/Loan Platforms – These platforms allow you to both take loans and provide liquidity to give loans. Loans are given based on terms created in code.
- Prediction Markets – These platforms are betting markets, where you make predictions on the outcome of an event, and someone else will take the otherside of the bet. It makes a direct bet between individuals without a bookmaker inbetween.
- Stablecoins/Pegged-Assets – These are tokens whose value is tied to an external asset, like USD, BTC, EUR, GOLD, etc.
- Yield Farms/Liquidity Mining – These are platforms where you can provide liquidity that is leant out to various DeFi projects, and an interest is earned in return for providing liquidity.
According to CNBC, 25% of households in the USA are either unbanked or underbanked. When applied globally, the numbers become worse. DeFi is about leveling the playing field, and providing everyone access to financial products, globally and without restriction.
The world of DeFi is just getting started.