DeFi - decentralized finance of the future
27.04.2021 | asorokin
Decentralized finance is an ecosystem of applications or services based on blockchain. Most DeFi projects are released on Ethereum, so users have the ability to get complete, reliable information, which increases trust in the system in general. All aspects of finance, both services and individual transactions, are represented in decentralized finance. Among other things, lending and securities trading can be singled out.
Features of DeFi
DiFi is somewhat similar to cryptocurrencies. If bitcoin or monero is a distributed system of monetary units, distributed finance projects provide access to management tools, enabling the use of traditional assets without the need to turn to intermediaries. In the classical market, the role of the latter can be played by exchanges, brokers and banks. DeFi projects are especially popular in those countries and regions where either the economy is underdeveloped, or the entrance to the market of financial services is extremely high.
The main feature of decentralized finance is the absence of centralized management. All business logic is written into a smart contract, which, once launched, can function without external intervention or with minimal necessary adjustments. This makes DeFi completely transparent, because the source code of the contract can be checked by third-party auditors, allowing to identify errors or weaknesses even before the project is launched.
A second, equally important factor that has made DeFi so popular is its wide availability. This can also be understood as the absence of borders - anyone who has access to the Internet can use the financial tool or create their own project in the ecosystem. A cryptocurrency wallet provides full access to smart contract management tools, with access appearing immediately after publication, without the need to go through complex commercial auditing procedures, as with a listing on conventional exchanges. Interest in DeFi will only depend on the attractiveness of the idea and its implementation.
Another feature is the ability to create composite products. For example, it is possible to create a decentralized financial instrument from a combination of stabelcoin and a prediction market, which is, in fact, DeFi itself. Thus, it is possible to bet, for example, in USDC on sports events in a decentralized bookmaker.
Advantages and disadvantages of DeFi
| Advantages | Disadvantages |
|---|---|
| Decentralization allows control of the system to be evenly distributed among a large number of participants, thus avoiding excessive regulation, and direct access to the ecosystem eliminates the institution of intermediation in financial transactions, which increases reliability and reduces the cost of services. | Decentralization also has some disadvantages. Not all network players always act in the best interest of the ecosystem and contribute to its prosperity. In this case, some players may act maliciously for their own benefit, or some participants may not participate in the life of the project, which reduces its reliability. |
| The system of smart contracts creates clear rules in which the decision is made by an absolute majority, and all participants in the ecosystem are subject to a single law. | The development is still conducted by a single team, which means the decision can be made by a small group of people. Although, to be fair, more and more DeFi projects are building their development system on the basis of active discussion in the community of ordinary users. |
| Open source increases user trust and gives the opportunity to develop the ecosystem, using already existing developments in new projects without the need to obtain permission from the author. | The increased interest in the technology is similar to the hype around ICOs from 2017, which means that now the market is somewhat overheated. In the future, those who invested in the project at the peak of interest may lose some of their money when the attention to DeFi cools somewhat and the technology loses its novelty. |
DeFi applications
The first use of DeFi was in the world of currencies. Smart contracts were used to issue tokens backed by real assets. Any assets, such as euros, U.S. dollars, or even physical bars of gold, can be used as collateral. The purchase of a token or part of it gives the holder the right to demand fiat collateral at any time. One peculiarity here is that there must be absolute trust in the issuing authority; there have been cases where unscrupulous founders have withdrawn collateral, bringing down the ecosystem.
Another popular way to use DeFi is direct lending. In this case, a decentralized pool collects liquidity in the form of deposits and then issues loans directly, without the need to involve third parties in the form of banks or credit brokers. In this case, the use of a smart contract system not only reduces transaction costs and intermediary fees, but also reduces counterparty risks.
Exchange transactions also find their use in decentralized financial transactions. A distributed exchange, as well as cryptocurrencies, operates on a blockchain network, which allows the movement of assets to be tracked. However, unlike classical intermediaries, decentralized exchanges avoid the need for verification. Thus, users do not need to give personal data to anyone. The exchange itself acts not as an intermediary, but only compares purchase orders and sales offers.
Decentralized prediction markets, in their essence, are the analogue of bookmaker’s offices. Here you can place a bet on an event for which the dispute may even be banned in one country or another. According to studies, the more people have a say in the outcome of an event, the greater the probability that the prediction will be correct. It is DeFi that will allow users to decide on what outcome to bet, and in case of winning, the profit is divided proportionally between all participants of the network.
The logical evolution of exchanges in decentralized finance is the so-called synthetic assets and tokenized securities. The former include non-calculated futures contracts, ETFs and other derivatives. The latter are a direct analogue of classical securities: stocks and bonds. Although the latter are used more in the decentralized lending market, they also exist in the form of secured tokens. The issuance of tokenized shares on decentralized finance platforms avoids the complicated procedure of entering the market, which most often requires the intermediation of investment banks or similar organizations.
Conclusion
DeFi is a new word in the principles of financial relations. It is decentralized finance that can become the basis of the economy of the new Internet era WEB 3.0, when from absolute centralization information will begin to be distributed evenly, which will give more freedom to mankind.