What Is Decentralized Finance?

What Is Decentralized Finance?

By Austin Reihl | Cyberfeed | 26 Jan 2021


DeFi is short for decentralized finance. The objective of DeFi is to give the users full control of their finances - this includes digital assets, protocols, smart contracts, and dApps built on the blockchain. Anybody can store, trade, and invest their digital assets securely and privately while earning a much higher return than from the traditional financial system. Since there are no third-parties handling your finances, you have complete control over your investments.

 

Centralization vs. Decentralization

 

The traditional finance market is centralized. Central authorities, like a government or a centralized bank, issue the currency that drives an economy. Therefore, the power to regulate the supply resides solely with them. We also pass the control of our assets to financial organizations like banks with the expectation of high returns, and this raises the question - what if central bodies decide to print more currency in response to a financial crisis, and it backfires?

 

Central bodies rely on humans, and human emotion can result in poor judgment and error. Take the case of the Venezuelan government: their monetary policies resulted in inflation exceeding 1,000,000% as per the IMF data, thus destroying the Venezuelan currency. All of these issues arise because of the centralization that currently underpins the global economy - it is not an open system. Thus, the solution is to decentralize, and with the implementation of blockchain technology, this has now become a possibility.

 

Decentralized Exchanges

 

A decentralized exchange (DEX) is a cryptocurrency exchange market that does not rely on a third-party service to hold user funds and allows for trading without the need for buyers and sellers to create liquidity (an order book). Uniswap (UNI) revolutionized the world of decentralized finance (DeFi) this past summer with the launch of UNI-V2 - users locking up to $3 billion in liquidity by mid-November. 

 

The total market value of UNI is tiny compared to traditional financial institutions, but it has seen exponential growth this year. With more projects and DeFi applications, we can expect to reach a genuinely decentralized reality where the traditional financial market is interoperable with digital assets on the blockchain in perfect sync.

 

Open Lending Protocols

 

Open lending protocols have become one the most popular services among other DeFi applications in recent years, thanks to the extensive use of Dai and liquidity pool (LP) designs such as Compound Finance (COMP). Open lending protocols exist on public blockchains, like Ethereum (ETH). They offer several advantages over traditional lending/crediting services:

 
  • Digital asset lending and borrowing

  • Collateralization of digital assets

  • Instantaneous settlement of transactions

  • Reduced costs with automation

  • No credit checks

  • Broader access to people that cannot tap into traditional services
 

Due to these capabilities, the ability to lend digital assets can be adopted globally.

 

Final Thoughts

 

Bitcoin and other early cryptocurrencies introduced a solution for peer-to-peer trading without the need for a third party – giving users complete control over their financial assets. However, these cryptocurrencies have not completely decentralized the financial system as they had promised. They have just decentralized the issuing of money and its storage. There are still several problems preventing blockchain from making the financial system a truly decentralized space.

 

DeFi is an open financial ecosystem where anybody can build financial tools and services in a decentralized manner. Developers across the globe can collaborate to create new products, leading to faster innovation and a secure network because all DeFi protocols are open-source, allowing anybody to build a new financial product on top of them. Decentralization has become a reality with innovative technologies built on blockchain technology - DEXs like UNI offer users total control of their finances, and as innovations like decentralized finance continue improving, our need to rely on traditional banking systems is no longer necessary.


Austin Reihl
Austin Reihl

Author. Creator. Musician.


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