by Lydia Ludmila 
Consider the traditional financial services you use every day, like savings, loans, trading, insurance, etc., becoming accessible to anyone in the world. And through DeFi, an individual can access a variety of financial services in a truly global marketplace where costly middlemen are replaced by interoperable apps.
Decentralized Finance intends to build a financial system that is accessible to everyone and removes the need to trust and rely on central financial authorities.
What are the problems DeFI try to solve?
Nowadays, almost all financial services are centralized, which means that there are entities behind the given institutions that have control over them. A good example in this case is the banks where money and savings are held by a very large group of people. This works well on a daily basis. But what can happen in a crisis situation?
It is the banks that have control over the money
Under normal circumstances, bank customers have no problems managing their money. However, in times of emergency, a bank may, for example, freeze funds in an account. Similarly, if a bank collapses or authorities fail to meet their obligations, the value of the money in the account may decrease or we may not have access to it.
To make it easier to imagine such a situation, we can look at Venezuela, which is plagued by hyperinflation caused by the government’s inept management of the state. Every day Bolivar, the country’s national currency, loses value. Citizens prefer to invest their money in more certain assets, such as cryptocurrencies.
Decentralized solutions seem to be a cure for such problems.
Another important disadvantage of relying solely on the banking system is that not everyone in the world has access to traditional banking and thus does not have access to some services such as taking loans and credits. DeFi is supposed to make these chances equal.
The idea is to allow anyone with internet access to be able to lend, borrow and bank without the need for middle men. Because yes, the only thing you need to participate in the DeFi sector is an internet connection. Defi gives easy access to financial services, especially for those who are isolated from the current financial system (1.7 billion people currently are unbanked because of geographic limitation, credit history or a lack of reliable banking infraestructure in their countries).
Now let’s dive into it!
Defi or Dapps?
DeFi depends heavily on Dapps. To understand DeFi’s capabilities, you need to understand the concept behind Dapps.
Dapps (Decentralized applications) are programs designed to function within decentralized networks. There is no central authority, corporations, or agency that monitors and approves the business functions of these applications.
Dapps require very little human intervention. Instead, these platforms integrate advanced smart contracts to streamline their business systems. Smart contracts can handle a huge variety of tasks from customer approval to making payments.
What are the main advantages of Defi?
Traditional finance relies on institutions such as banks to act as intermediaries, and courts to provide arbitration.
- DEFI is decentralized
The purpose of DeFi is to create a financial ecosystem that’s the opposite of the centralized system we all know: a system that’s open-source, permissionless, transparent, and devoid of any central authority. Within DeFi, users get to control their assets and they interact with the DeFi ecosystem through dApps.
DeFi applications do not need any intermediaries or arbitrators. The code specifies the resolution of every possible dispute, and the users maintain control over their funds at all times.
As these new financial services are deployed on top of blockchains, single points of failure are eliminated. The data is recorded on the blockchain and spread across thousands of nodes, making censorship or the potential shutdown of a service a complicated undertaking.
- DEFI is global
Another significant advantage of such an open ecosystem is that Defi allows EVERYONE to have access to the same DeFi services no matter where you are.
Technically speaking, this allows anyone with internet access to have a wide array of financial services. Due to its permissionless nature, users don’t have geographical restrictions. So even when they block IP addresses, users can still access the network remotely via VPN. Apart from geographic limitation, traditional financial services also favour the wealthier population. Clients with more assets typically enjoy better rates and have access to wealth management tools. DeFi minimizes the inequality and users can enjoy similar services regardless of their size.
DeFi applications seek to take accessibility one step further. By building products on a decentralized network like Ethereum, anyone with an internet connection is able to access lending services, complex financial products, stable stores of value, investment and trading opportunities. Since DeFi products are simply code distributed across a decentralized network, they can also never be shut down or denied to those who want to use them.
- Earn money on your money
Another significant advantage of such an open ecosystem is that Defi allows EVERYONE to have access to the same DeFi services no matter where you are.
What are the usecases of Decentralized finance?
Borrowing and Lending (Open lending protocol)
Open lending protocols are one of the most popular types of applications that are part of the DeFi ecosystem. As the name suggests, this is a digital money lending platform built on blockchain. Just like a bank, users deposit their money and when someone else borrows the digital assets they earn interests. However, instead of intermediaries, here the smart contracts dictate the loan terms, connect lenders and borrowers, and are in charge of distributing the interest. The system works in a very similar way to FinTechs or traditional finance. But DeFi usually offers better interest terms, and loans are generally approved almost instantly.
Among the most popular projects are lending protocols Aave, Maker and Compound. These are protocols that let you borrow cryptocurrencies instantaneously and earn interest from lending out cryptocurrencies. With billions of dollars of value locked up in their smart contracts the premise is simple: you can loan out cryptocurrency tokens or borrow them. All the major protocols are all based on Ethereum, meaning that you can lend or borrow any ERC20 token.I will cover each of them in an article.
Open, decentralized borrowing and lending have many advantages over the traditional credit system. These include instant transaction settlement, the ability to collateralize digital assets, no credit checks, and potential standardization in the future.
Monetary banking services
As DeFi applications are, by definition, financial applications, monetary banking services are an obvious use case for them. These can include the issuance of stablecoins, mortgages, and insurance.
What are stablecoins?
Unlike other crypto coins which have a volatile value, stablecoins are blockchain-issued tokens designed to hold on to a specific value.
This is stablecoins’ job to remove volatility and ensure stability.
This is usually done by pegging it with fiat currencies like the US dollar (fiat-collateralized stablecoins), but also it can be pegged with other assets like gold.
As cryptocurrency prices can fluctuate rapidly at times, decentralized stablecoins could be adopted for everyday use as digital cash that is not issued and monitored by a central authority.
Decentralized Exchanges
Unlike centralized exchanges like Coinbase or Binance, decentralized exchanges have peer-to-peer transactions of digital assets between two parties on the blockchain with no third-parties involved.
This means that these platforms allow users to trade digital assets without the need for a trusted intermediary (the exchange) to hold their funds. The trades are made directly between user wallets with the help of smart contracts. The advantage of this approach is that there are no sign-ups, no identity verification, or any withdrawal fees.
Creations such as decentralized exchanges (DEX), investment pools, financial derivatives, staking systems, prediction markets, and more are possible thanks to DeFi.
Examples of decentralized exchanges are Uniswap, 0x and Kyber Network. (I’ll cover it in an article).
Derivatives
Derivatives markets are where buyers and sellers exchange contracts based on the expected future value of an asset. These assets can be anything from cryptocurrencies to future event outcomes to real-world stocks and bonds.
In protocols like Synthetix, users can trade real world assets such as stocks, currencies and precious metals in the form of tokens on Ethereum.
Lastly, protocols like dYdX offer users the possibility to trade margin tokens, allowing traders exposure to leverage short or long positions in various markets.
Is there any risk involved with Defi?
If you have been in the crypto world long enough, you will surely remember the ICO boom of 2017 and 2018. And you will also know what this meant for many: millionaire losses and scams everywhere. In Defi there are hundreds of projects masquerading as DeFi to scam those who fall into the trap of making quick and easy money. So people, be careful!
With any high return product, there is always some risk involved and Defi has its fair share too. Securely handling cryptocurrencies and using decentralized finance tools require specialized knowledge. DeFi applications transfer the responsibility from the intermediaries to the user. This can be a negative aspect for many. If something goes wrong, if you transfer your crypto in a wrong way there is no bank in between to call and your crypto will be lost forever.
In decentralized finance it’s the user’s responsibility to keep their key and holdings secret, use a hardware wallet and multi-factor authentication. I’ll cover the safest way to store your cryptocurrencies, don’t worry.
What role do smart contracts have in defi?
Most of the existing and potential applications of Decentralizrd Finance involve the creation and execution of smart contracts. While a usual contract uses legal terminology to specify the terms of the relationship between the entities entering the contract, a smart contract uses computer code.
Since their terms are written in a computer code, smart contracts have the unique ability also to enforce those terms through computer code. This enables the reliable execution and automation of a large number of business processes that currently require human manual supervision.
Using smart contracts is faster, easier, and reduces risk for both parties.
Don’t know what is a smart contract? I’ve written a complete guide for beginners here.
My Thoughts
A person is not truly free unless they have financial liberty
DeFi proposes solutions to give economic power back to the people by creating a financial system that is accessible, efficient, and transparent. It is an exciting development for the blockchain space that brings real, useful financial services like borrowing, lending, asset issuance, prediction markets, and more to anyone, anywhere.
With more and more users looking to adopt DeFi services, it will be interesting to see how DeFi or other types of Blockchain technology will integrate into our lives.
As of now, Ethereum is the home to all the major Defi Projects. But other blockchains are building projects like Polkadot or Cosmos which shows that the industry will expand to more blockchains in the future.
Interoperability
DeFi projects will become more interoperable. Bitcoin can already be used on Ethereum in the form of Wrapped BTC, and more initiatives to enable cross-blockchain compatibility are in the works, most notably Tendermint’s Cosmos and the Polkadot project.
New blockchains developing Defi projects
DeFi will expand to other blockchains. Once the domain of Ethereum, other blockchains are eying up DeFi. Huobi, Conflux, Binance and others are all launching incubators and platforms for DeFi projects, many of which have no connection to Ethereum.
Centralized and decentralized finance will interact
DeFi will interact with centralized finance. Imagine a future in which your credit score could be linked to a decentralized lending protocol? What if you could stake your house as collateral for a crypto loan? What if your high-street bank let you buy and hold decentralized stablecoins? All these are in the works. Institutional investors are already starting to put money into its protocols.
As you can see here, Defi will take power from large centralized organizations and put it in the hands of the open-source community and the individual. The future of DeFi is bright and it is just starting its conquest towards traditional financial sectors.
DeFi could be the birth of a global financial revolution.
Click here to read about the most popular usecases in Decentralized Finance.
As always feel free to leave a comment down below for any question you have about this article and I’ll be answering! Remember, we are all here to learn and there are no stupid questions.
Thank you !
