There has been a recent surge in platforms and products that are offering something called ‘DeFi services’. With its rapid rise to popularity and success, it only makes sense to learn more about it and understand why exactly it is making waves.
What is it?
‘DeFi’ is a shortened version of the term ‘decentralized finance’. In essence, it is just standard financial tools whose foundation is on a blockchain; specifically Ethereum. Their predictions are primarily on open-source protocols or modular frameworks.
The primary open financial sectors on Ethereum are the following:
- Prediction markets
- Open lending protocols
- Issuance platforms and investing
- Exchanges and open marketplaces
They are mostly for constructing and later distributing digital assets. Furthermore, their design allows them to discuss the prominent advantages of operating on a public blockchain. Such advantages include censorship-resistance and comparatively better access to financial services.
The act of decentralization is not exactly discreet, especially when you apply it to everything. A majority of DeFi applications keep this in mind and provide composite digital asset/traditional financial services. One of these kinds of services includes BlockFi.
A substitute term – one that embodies more of the continuous spotlight on financial products – is ‘open finance’. This is a special ecosystem of unified digital assets, blockchains, and open protocols. Here, they are trying to gain approval for themselves by way of traditional financial structures.
Open lending protocols
These protocols are on the receiving end of the most attention than any other categories of open finance on Ethereum. Open, decentralized lending provides a lot of advantages over traditional credit structures. These include:
- Assimilation with digital asset lending/borrowing
- The collateralization of digital assets
- Instantaneous transaction settlement and novel secured lending techniques
- No credit checks, which means there is extensive access to people that cannot access traditional services
- Uniformity and interoperability; both of which can also cut down on costs with automation
Issuance Platforms & Investing
Issuance platforms encompass a wide range of platforms, which include numerous exchanges that also function as issuance mediums. A considerable portion of issuance platforms is focusing heavily on the security token market. Here, pending regulation and the assurance of more flexible securities is fast-becoming a widespread concept in the crypto field.
Decentralized Prediction Markets
Decentralized prediction markets are a compelling component of open finance. They are complex, but they also have great potential. Last year, Augur launched as a censorship-resistant prediction market that draws from Ethereum. There are several other platforms, like Gnosis, that will soon follow.
Exchanges & Open Marketplaces
Exchanges in open finance mostly refer to decentralized exchange (DEX) protocols and P2P marketplaces. DEXs are P2P exchanges of assets on Ethereum that exist between two parties; no third-party acts as the intermediary in a transaction. Examples of these third-parties include Coinbase and other centralized exchanges. DEXs experience a lack of volumes because of their obscurity and non-friendly UIs. As a result, they are still stuck in their early adoption stages.
Stablecoins have become a prominent entity in the cryptocurrency markets in recent years. Along with them are new models for token issuance, reserve auditing, and price peg management. Stablecoins are really just blockchain-issued tokens whose design helps preserve a stable peg with an outside asset. In most cases, it is the USD, however, there are other instances where it is gold or another asset.
Centralization of finances
Financial markets have the capability of driving the welfare and success of a society by making interesting ideas a reality. However, the overall power in finance is generally centralized. A good chunk of people experiences exclusion from certain decisions about what should receive funding. Moreover, they only garner only a small share of the profits from whatever projects they do.
The system behind centralized finances is that people will transfer control over their assets to banks and other financial intermediaries. This way, professional managers can handle money in the markets wisely. Their basic belief is that they will garner higher returns, thus account holders will benefit as well.
There is a catch to this. The outcome is making sure that control and risk are the focal points of the system. The conventional banker possesses a great amount of experience, however, they are still susceptible to imperfection. On top of that, they are capable of failing to notice risks within the markets, like the 2008 housing bubble. By having complete control over all the money, the risk level escalates at the center. This consequently places the entire system in a dangerous and vulnerable position.
A start, but not quite complete
The creation of Bitcoin back in 2008 was thanks to Satoshi Nakamoto. Its claim to fame was the fact that it was the first-ever solution to have global peer-to-peer trade settlements. Without intermediaries, individuals are able to keep tabs on their assets. Be that as it may, Bitcoin and various early cryptocurrencies only decentralized money distribution and storage. The same cannot be said for accessibility to the financial system.
Two of the biggest problems with the current state of the crypto space are extremely prominent. First and foremost, protocols are decentralized and draw their information from consensus algorithms. Additionally, most of the access points leading to the system – like exchanges – are still centralized. Not only that, but there are numerous crypto projects whose management is through centralized organizations or companies. They, too, frequently lack a sense of transparency or responsibility. They fail to openly showcase the development of the ecosystem’s new sections. The result of this is the blockchain having yet to open up finance.
So, is there a solution for this? It does not seem right to have most people be locked out from their own assets. Well, this is where DeFi comes in.
Decentralization of finances
Already there are many fintech (financial technology) firms and new-age banks that are promising to give consumers more control. These, unsurprisingly, are largely deceptive promises, as banks are still in control of the assets. The only thing the customer can do is trust that their bank will properly look after it. They are comparatively faster and much more beneficial, but that does not make them all that dissimilar from traditional banking.
Truth be told, the only way to achieve concrete disruption is with absolute individual control; over assets and over access.
It is with great fortune that technology is gradually starting to make this possible.
A great number of financial product builders are transitioning towards utilizing open-source protocols. With this, they will be able to exchange assets by way of platforms that are subject to decentralization. The newer platforms possess two remarkable advantages that the current state of finances does not have.
First of all, people will have the ability to unlock a lot of forms of value; some familiar, some new. They can do so without having to depend solely on intermediaries to manage their assets for a commission. It is basically accessible to pretty much everybody and there is no control at the center of it all.
Secondly, every protocol is open-source. This means that anyone is able to construct new financial products on top of them. People from all over the world can work together and conjure up brand new forms for value creation. With this system, there can be an emergence of faster innovation and more stable network effects. These effects could potentially escalate with more users and builders making the transition towards the platforms.
What the future holds
DeFi is providing users with a wide range of prevalent financial vehicles and marketplaces. These typically guarantee that the individual is the primary, round-the-clock overseer of their assets. Nowadays, if you recall, each one of these protocols draws primarily from Ethereum smart contracts.
The ones that show the most promise are the following:
- 0x or KyberNetwork, which are decentralized exchanges.
- MelonPort, which is a smart contract asset management fund.
- Dai, which is a non-asset-backed stablecoin. It has a reliable value that is useful for transferring and hedging.
- Token baskets, which are essentially the decentralized counterpart of ETFs, by way of the Set protocol.
- Compound and/or Dharma, which are both tokenized debt platforms. They are especially useful for borrowing and loaning.
For the time being, the markets are small in size. Despite this, they promise the public with a global financial marketplace. One that has programmable stores of value whose services extend to the individual. On top of that, they belong to the individual.