Before coming to the substance and talk about Decentralized Finance (DeFi), it is essential to contextualize about its philosophical and functional origin, to understand how its value proposition differs from that of traditional finance.
In 2009, Bitcoin was conceptualized by Satoshi Nakamoto as a “User-to-User Electronic Cash System.” This innovative notion made it possible to lay the foundations for a global, decentralized, neutral, censorship-resistant, and open platform that would complement (or replace) the traditional value exchange system.
Nakamoto’s whitepaper describes the operation of a new type of Distributed Registration (DLT). Through a consensus protocol accepted by all network participants, a copy of the DLT can be dispersed around the world, avoiding a central point of failure or control.
This first public blockchain is known as Bitcoin.
Ten years after its invention, many similar projects have been created, based on the same principles of decentralization and its underlying technology: the blockchain. Being open-source, many enthusiasts, thinkers, and programmers have set their sights and contributed to its development.
Long-time ago, countries in the Western Hemisphere separated the power of the Church and the State. Bitcoin’s proposal is similar: to separate money from politics. A virtual currency regulated by mathematics, oblivious to whims or sectoral manipulations, managed by people, global and based on the Internet.
The guardians of money.
The potential of these decentralized systems is diminished because it depends on the traditional political-economic system. Until the population massively adopts crypto assets, the access and exit ramps (e.g., exchanges and banks), will be a necessary interface so that 95% of the population that does not own cryptocurrenciescan transform from one type of money (fiat) to another (crypto assets).
From a simplistic perspective, the logic behind the global financial system is based on the control of monetary issue by States. Banking institutions and financial intermediaries exercise the administration of these assets.
These guardians receive compensation by offering their services and citizens, give up its autonomy over the control of their money over the promise of an adequate safeguard and convenient access to their funds.
However, centralized systems are not infallible. Global financial crises, such as 2007-2008 one, characterize this point and show that when control is in the hands of few actors, the accumulated risk tends to threaten the stability of the entire system, accelerating its entropy.
DEFI as an evolution of the fin-tech movement
Measures such as PSD2, in Europe, have opened a necessary gateway for innovation in the financial sector. In recent years, critical regulatory advances have been made possible for new startups to create efficient financial applications and tools, which was previously impossible to imagine.
Despite this, it is anachronistic that in an era dominated by exponential technologies such as Artificial Intelligence, Machine Learning and supercomputer networks, such a slow system -SWIFT- continues to handle most international banking transactions.
Fin-tech represents evolution, and its advantages are evident. In this cocktail of accelerated innovations, which occurred in the first decades of the twentieth century, it is worth thinking about the next step after the advent and massification of fin-tech applications.
In a context where citizens gradually become more aware of the value of preserving control of their personal information and the importance of privacy amid the digital age, we cannot unlink the fin-tech concept from pro-decentralization ideas. Therefore, the DeFi could be in some cases, the natural evolution of fin-tech.
Fin-tech is undoubtedly a necessary link in this new wave of decentralized applications for financial affairs management, and the response of a generation that understands digital transformation as an unstoppable, essential, and positive process.
Now, after this long preamble:
What are the DeFi?
We can define DeFi as the construction of an alternative financial system, which operates under the concepts of decentralized governance, neutrality, privacy, inclusion, openness, and transparency.
The autonomy offered by the DeFi would displace the central control exercised by governments and large companies.
Some point out that the DeFi is a rebranding of another similar concept, “Open Finance,” an older notion that has been around longer, occupying threads in pro-libertarian forums and been the central topic of sporadic gatherings in universities. DeFi is possible thanks to platforms such as Bitcoin and Ethereum, which act as its first layer so that they can operate.
DeFi today. Some applications and services.
Lightning Network: is payment channels network that works on Bitcoin. It allows instant transactions in BTC. It has more than 4500 nodes and a processing capacity of $ 9 million.
Lightning Network has, in turn, served for fin-tech companies, such as foldapp.com, to offer payments of tangible products and services with bitcoin (air tickets, department stores, coffee shops, etc.). This is an excellent example of the binomial fin-tech / DeFi.
MakerDAO: it is a platform that supports the value of a stablecoin anchored to the dollar price, DAI, through a system of Collateralized Debt Positions (CDP) in ether (ETH). This project dominates 51% of DeFi’s market ($514.2 million).
Compound: It is a decentralized protocol on Ethereum that allows users to earn interest by lending their crypto assets. It offers variable interest rates, automatically adjusted by an algorithm. In some cases, it pays up to 18% APR.
Decentralized Exchanges (DEX): these are platforms that allow the exchange of crypto assets, making it possible to keep control of your private keys at all times. In Dex.ag you can see the main rates of 11 DEXes.
Challenges of the DeFi
As happens with many of the blockchain-based solutions, one of the most significant entry barriers for DeFi protocols is the complex they are for the average user. Concepts such as private keys, cold wallets, confirmation times and hardforks, are equivalent to hearing foreign language words for a monolingual citizen.
However, there have been advances. Dharma, a Silicon Valley startup, which offers loans and interest payments at DAI, is an example of simplification and friendly interface.
Another challenge that faces DeFi is the eventual fragility of smart contracts. The so-called smart contracts regulate the activity and functionality of these platforms. If they are hacked or there is a backdoor in their code, they could put user’s funds at risk.
It is worth mentioning that the main DeFi products used to be continuously audited by prestigious computer security firms.
On the other side of the coin, being open-source, its development is not stagnant, and progress is in the hands of thousands, but millions, of programmers worldwide.
There is a long way to go. We will see in the months – or years – to come how these technologies advance and what will be the benefits they will bring to thousands – or millions – of people around the world. Feel free to go through the Bitcaribe Academy to learn more about the crypto industry!
