DeFi - Why You Should Care What It Is

The DeFi revolution is around the corner, but what exactly is DeFi?

DeFi, which is the nifty name for “decentralised finance” (or “open” finance) is a broad category of financial applications being developed on open, decentralised networks.

Yeee gawd… all this jargon can boggle the brain. But stay with me, it’s worth knowing this stuff.

The goal of the DeFi revolution is to build a financial system native to the blockchain that recreates and improves upon ineffective and inefficient legacy financial systems.

For most of us, DeFi is going to be completely new and it’s going to become an increasingly important part of our lives. 

It’s going to be different from what
we’re used to in traditional finance.
And it will require us to deal with change. 

It’s the future… and people who are at the forefront of the future are the ones that benefit the most. That’s why it’s important that you are informed and understand what it is about – so you can recognise and take advantage of new opportunities as they arise.

There are a number of features that differentiate DeFi from traditional finance and the systems and networks that governments and institutions use today.

These features can help level the playing field.

That’s because DeFi is:

• Permissionless: DeFi provides financial services to anyone with an internet connection, boosting financial inclusion – wealth, status, or location don’t determine access.
• Decentralised: Records are kept simultaneously across thousands of computers, instead of a few central servers.
• Trustless: No central party is needed to ensure a valid transaction.
• Transparent: All transactions are publicly auditable.
• Censorship-Resistant: A third party cannot reverse or invalidate a user’s transaction.
• Programmable: Developers can program business logic into financial services, leading to more efficient processes.
• Composable: This enables the creation of new financial products and services by combining different protocols.

Suffice to say, it’s an exciting time to be understanding what DeFi is, what it could do to democratise the financial sector and, mostly, how to benefit from it.

Today DeFi applications are tiny and nibbling at the edges of traditional finance. But when we look back in years to come, it won’t surprise me if, in the long run, DeFi has completely replaced today’s financial system.

Understanding DeFi

One way to understand DeFi is to think about the way that centralised finance works.

In the centralised systems that dominate our world at the moment, money and assets are predominantly held by banks and other financial institutions. These companies are sometimes called the “custodians” of wealth – they “look after” our money, our shares, our interest-earning deposits, and so on. Mostly, they maintain database entries in which our names appear next to bits of information and numbers that define our financial status. Of course, they charge fees for maintaining these databases.

When it comes to transacting, there are lots of third parties involved. There are financial institutions who specialise in payment channels (like credit card companies) or in providing guarantees for goods moving across borders, and so on.

When we move money or assets from one “custodian” to another, there may be several third parties each charging a fee. If you draw cash from an interbank ATM, for example, you might get charged by both the third party bank and your own bank. When you swipe your debit card to buy groceries, the vendor pays a fee and, depending where you are, you might pay a fee as well.

In addition to layered fees, financial transactions can be complicated in other ways as well. Even a simple purchase can involve a series of behind the scenes transactions: the charge goes from the checkout point to the acquiring bank (the store’s bank), which forwards the details to a credit/debit card network. The network performs security checks and sends the request for payment to your bank, where your account is checked (a database query). If your bank approves the charges it sends back messages through the network, back to the acquiring bank, and on to the merchant. (And all of these behind-the-scenes parties are getting a small piece of the fees being charged.)

DeFi aims to simplify everything by getting rid
of most of these third parties (or “intermediaries”).

Using the same blockchain technology that drives crypto currencies like Bitcoin, DeFi puts everything in one place (the blockchain “database”), allowing financial players to deal directly with one another.

This creates “peer-to-peer” transactions that get rid of middlemen. For example, using DeFi technology, someone needing to borrow money could be matched via an algorithm with someone willing to lend money. If the required amount, interest rate and other details are matched, the transaction is verified using the same mechanisms used to verify crypto transactions. The completed encrypted transaction then exists in the blockchain where it is secure and verified. Each repayment of the loan would follow the same process.

Investing in DeFi

Defi is in its infancy. It’s a technology of the future.

Right now DeFi is almost synonymous with the Ethereum network but this should change as DeFi technologies develop.

Ethereum is similar to Bitcoin in that it functions as a cryptocurrency, but unlike Bitcoin it can be linked to “smart contracts” (like the peer-to-peer credit transaction described above).

Investing in Ether or other coins that use the same technology is currently the simplest way of getting broad-based exposure to the DeFi revolution. In the next few years it will become possible to invest directly in products that exploit the power of decentralised finance.

Would you like to share your thoughts on DeFi? Join the conversation on the Facebook Community Page (it’s free) and see what others are saying.

As always, thanks for reading and sharing.

Love

Ann