The term “DeFi” stands for Decentralised Finance, and it’s increasingly popular in our space. The emergence of layer 2, and the expansion of the blockchain world beyond established players such as bitcoin, means this term is right on the crest of the crypto zeitgeist.
But what exactly does DeFi mean?
To explain, we must first break it all down, right to the fundamentals. In fact, we need to start by explaining finance itself.
What is finance?
Finance, in general, refers to a system that facilitates the movement and allocation of capital, with the aim of growing economies and generating returns for capital holders. This includes activities such as payments, exchange, investment, borrowing, and lending. It also includes all products that can be derived to support these activities, such as insurance, leveraged products and futures trading.
Unless you work in a financial institution, you probably don’t deal with these terms day to day. However, you are almost certainly using the system these terms describe. Whether it is for simply paying with our debit card at the supermarket or more complex transactions, like the investment of our pension contributions in a specialist fund, it’s all part of the financial system.
What is centralisation?
When we centralise something, we give control to a group of people in one particular place. In other words, this entity (whether it be a business, a public institution or an entire country) is placed under the control of a single person, or group.
The financial systems described above are currently centralised. They are all run by central bodies which decide the actions they take.
So, for example, a central bank decides the interest rate on the currency you use, while your own local bank is controlled by a board of directors, who decide on lending and overdraft policies.
Why is centralisation problematic?
Whilst centralisation may seem convenient, it creates huge problems.
The U.S. Federal Reserve’s stimulus programme is a good example of this. At the start of the Covid-19, America’s central bank embarked on a huge programme of money-printing: by the end of 2020, more than 20% of all the dollars in circulation had been printed that year.
The programme was designed to kickstart the economy, but it also created inflationary pressures for the person in the street: with all this dollar-printing, an item that had previously cost $1 jumped to $1.20. And why? Because a bunch of old guys in a room in the U.S. said so!
It’s also worth thinking about the way your bank or broker handles your funds. Whilst your funds are kept safe, you cannot move them without the bank’s cooperation. Likewise, your investments are tied up by your broker; you can’t move them to a different broker or access the market directly.
What is Decentralisation?
In 2009 the concept of the blockchain was introduced to the world with the creation of Bitcoin.
Later on, the technology evolved with the development of programmable blockchains, the most widely used of which is Ethereum. This new breed of blockchains allow users to create more complex transactions than mere direct payments; developers can add smart contracts (rules which trigger pre-determined actions in response to specific user behaviours) and the blockchain will verify that these rules as valid without needing a centralised, trusted party to verify them.
This huge paradigm leap allows for complex programs and financial products to be constructed. These financial programs and products do not require a single party to operate them, and thus are incredibly resilient as there is no single point of failure.
Another huge benefit is that these systems are permissionless, which means that anyone in the world can access them on equal terms.
So what is DeFi?
DeFi refers to the term “decentralised finance”. In the last 2 years, decentralised financial products have been built at an incredible pace and anyone can now use a suite of products and services. For example, anyone can now:
- Send and receive funds globally (payments)
- Exchange tokens for each other (Through decentralised exchanges)
- Lend funds to receive an interest
- Borrow funds
- Trade derivative products such as options, futures, bonds etc
DeFi is building towards an alternative financial system to what already exists using a completely different foundation. Hence, among its early adopters, it’s not seen as “buying crypto” but more like migrating your funds to their blockchain-compatible form, similar to how in the 80s/90s people migrated from cash to bank accounts.
Why does DeFi matter?
There are many pragmatic reasons as to why DeFi is the next step in the story of money:
- It’s more efficient to have computers do the work than humans. This brings the cost for the end-user as thousands of people can be replaced by a few lines of code.
- It gives millions of people access to a financial system that simply does not exist for them (nearly one-third of the world’s population still does not have access to a bank account).
However, the true reason why DeFi matters is that no genius mind or company can compete with the innovation that is unleashed when everyone in the world is able to build, contribute and use a system.
DeFi allows the entire planet to take ownership of the financial systems they use. This isn’t the future anymore; it’s the present.
The world is now more united than ever, and the move towards remote working in the wake of Covid-19 will only accelerate this trend. DeFi is perfectly tuned to this new reality.
DeversiFi makes DeFi easy. Swap, Invest and Send without paying Ethereum network fees.