The Decentralized Finance Concept (Defi): What Is It?

Feb 11, 2022
4 min read

Cryptocurrencies have made a splash these days and this trillion-dollar industry has also caused financial disruption around the world.

Cryptocurrencies have a remarkable history from the 1980s to the present day. Bitcoin, the first cryptocurrency, has seen spectacular growth, yet not much adoption by financial services is due to its inherent lack of stability.

Mainstream institutions stay away from Bitcoin because of the significant price volatility. And that's why it's a poor asset for a perfect investment plan.

Change is the hallmark of crypto space. Decentralized finance (DeFi) is a current trend. Of course, if you're learning DeFi for the first time, you'll be pretty excited by the time we lead you on.

An Overview of Decentralized Finance (DeFi)

DeFi is a short-term acronym for decentralized finance for ongoing projects and applications in the public blockchain sector that has disrupted the traditional financial world.

Let us look a little further, DeFi refers to financial applications built on blockchain technologies and often brings the role of smart contracts. What are smart contracts? They are automatic enforceable agreements to avoid intermediaries and simply require an internet connection to be accessible.

Defining Financial Innovation, or DeFi, as a set of applications and peer-to-peer protocols developed on decentralized blockchain networks that allows lending, borrowing, and trading of financial tools with no access rights required.

DeFi apps are currently built using the Ethereum network, but another generation of public networks is emerging that can provide superior speed, security, scalability, and cost-efficiency.

Smart Contracts: A Role to Play

With smart contracts, multiple parties can interact without the need for a centralized intermediary through Turing-complete programming languages. The ability of blockchains to leverage smart contracts has made them ideal for developing financial applications.

DeFi's History - How Did It Start?

Bartering was the way humans exchanged goods and services in the beginning, but, as humans evolved, economies evolved: We invented currency to facilitate the exchange of goods and services. Coins brought innovations and improved economies, but progress has a price.

Central authorities have historically issued currencies to support our economies, endowing them with more power as people grew to trust them. The centralized authorities have however occasionally broken trust, leading to questions about their ability to administer the money. DeFi was created with the aim of creating an open financial system that minimizes the reliance on centralized authority.

DeFi's genesis is claimed to have begun with the launch of Bitcoin in 2009, which was the first p2p digital money built on top of the blockchain. The introduction of blockchain technology into the legacy financial world using Bitcoin was an essential next step towards decentralizing legacy financial systems. Ethereum and, in particular, smart contracts, made this all possible in 2015.

In the financial industry, Ethereum technology was the first 2nd generation blockchain to capitalize on the potential of this technology within the financial sector. It encouraged businesses and enterprises to build and deploy projects that formed the ecosystem of DeFi.

With DeFi, there was the opportunity to establish a transparent, robust and independent financial system. The pivotal year for financial applications took place in 2017, when projects began facilitating more features than only money transfers.

Finance Under Centralized Control: Challenges

It is through financial markets that great ideas can be developed and society can prosper. These markets are still dominated by a centralized power. In the current financial system, people ensure their assets are held by intermediaries, such as banks and financial institutions. In this way, risk and control remain at the centre of these systems.

The 2008 financial crisis demonstrated that bankers and institutions failed to see the risks in the market in the past. The centralization of money leads to the accumulation of risk at the centre, which poses a danger to the system as a whole.

Initially designed to give individuals full control over their assets, Bitcoin and early cryptocurrency weren't decentralized until they were used for issuance and storage. Up until the advent of smart contracts, it was difficult to provide access to a broader set of financial instruments.

DeFi Protocols

DeFi has become a full-fledged ecosystem of protocols and applications that deliver value to millions of users. DeFi ecosystems have been securing over $30 billion in assets, making it one of the fastest-growing segments within the public blockchain space.

Lending and Borrowing Through DeFi

The introduction of DeFi allowed lending and borrowing to take on a new direction. A decentralized lending model often referred to as 'Open Finance', offered crypto holders the opportunity to gain annual returns on their loans. In decentralized borrowing, individual borrowers could borrow money at a set interest rate.

Lending and borrowing are intended to enhance financial service use cases while meeting the needs of the cryptocurrency community.

Decentralized Exchanges

The Decentralized Exchange (DEx) is one of the core features of DeFi, locking the maximum amount of capital compared to other DeFi protocols. DExs allow users to exchange tokens with other assets, without a centralized intermediary. A centralized exchange (traditional exchange) offers similar options, but the investments available depend on its discretion and costs. One of the negative aspects of CExs, and addressed by DExs, is the extra fee charged on each transaction.

What the Future Holds for DeFi

A revolution is taking place in the functionality of money as a result of the introduction of distributed ledger technology. It is the first time in history that a global financial system is being shaped by a worldwide population. The decentralized finance world is actively created by everyone who can participate in the governance of DeFi protocols.

In spite of some inevitable obstacles that come with operating on the bleeding edge of innovation, the world of decentralized finance is on the path to prosperity. It's hard to predict how this space will develop over time once the power to build financial services democratizes. However, when Defi and fintech intersect and integrate, we'll reach a tipping point where fledgling financial technology becomes a component of a new financial system. One that embodies the ideals of speed, security, accessibility, and egalitarianism.