If you live in the crypto space for a day, the acronym ‘DeFi’ comes your way almost twice per hour. No doubt, my statistics is right…or very close to it. The crypto space is a very dynamic environment and everything seems to be moving fast, we tend to forget the past so quick, because as a matter of fact, decentralized financial system is almost a summary of blockchains with cryptocurrencies running on them. Simply put, decentralized financial systems are as old as cryptocurrency and blockchain technology itself. So why the buzz? I hardly get it. Like a blind man regaining his site for the first time, we seen to be realizing our environment for the first time.
Why the buzz? Forgive my curiosity, I repeat questions when confused…lol. But that’s ‘by the way’ though. I get it, the recent proliferation of decentralized financial system blockchain projects and the expansion of areas of application decentralized financial systems has drawn the attention of the cryptocurrency community to the concept and many are stuck with the question, ‘what is DeFi?’. Probably the acronym sounds somewhat exotic and one could easily get confused as to what this really means.
For ‘chart watchers’ like myself, decentralized finance projects have been blazing hot over the past couple of weeks, tokens like Loopring coin, Compound token and KAVA token have seen reasonable greens with loopring coin seeing over 5x gains at its peak. Sad enough, we just stand and watch! But that’s OK.
Decentralized financial system (DeFi) is an audacious move to decentralize core financial activities such as financial management, payment, investment, lending , and insurance.
DeFi is a blockchain notion, it encompasses every attempt by blockchain and cryptocurrency projects to create a decentralized replacement or alternatives to real life financial activities. From the bitcoin blockchain itself and its lightning network to decentralized exchanges and financial institutions built on the blockchain; blockchain technology have dived deep into the economic sector and is making attempts to create a new and better way of handling financial activities.
Decentralized financial systems comprises applications built on top of blockchains which facilitates permissionless financial services and provides a seamless option for running financial activities. DeFi hopes to introduce the core virtues of blockchain technology to the financial system. The bitcoin blockchain introduced the concept of ‘decentralized means of payment’ which runs on a distributed ledger system, the blockchain. Thus, marking the onset of decentralized financial systems.
Sequel to the creation of bitcoin and its blockchain, similar projects have emerged which also offers solutions and attempts to modify certain sectors, including the financial sector, these early and contemporary blockchain projects which offers solutions and modifies the financial sector form the bulk of DeFi.
Bitcoin blockchain housed the first DeFi, the bitcoin cryptocurrency this was followed closely by other blockchain projects with similar ideas. Contemporary and emerging DeFi projects are however, expanding the scope of decentralized financial system, shifting the paradigm from ‘portable means’ of payments to smart contract applications running independently on a parent blockchain and offering advanced financial services such as insurance, lending, wealth management and an array of other financial management using blockchain resources and exhibiting desired blockchain features such immutability, security, privacy, speed and interoperability.
Augur smart contract project offers decentralized betting services. one of the earliest DeFi project on ethereum blockchain. Source
Smart contract blockchains are hence home to DeFi projects, ethereum particularly has housed majority of DeFi projects. Augur, one of the earliest smart contract projects on the ethereum blockchain and a popular DeFi project offers a decentralized alternative to advanced financial instruments such as index trackers and futures. Stable coin; DAI(SAI) runs the ethereum blockchain and provides a decentralized alternative to relatively stable currencies. EOS blockchain and the TRON blockchain smart contract layers also facilitates DeFi and provides resources which allows the project to thrive.
Recent statistics have shown a steep rise in the amount of tokens locked on the blockchain as a part of the requirements to create smart contracts, this rise gives an insight on the rate of proliferation of DeFi projects, even without this evidence, Decentralized financial systems are on the rise as the traditional systems have steady exhibited some level of incompetence.
Is the time now? I had to wait for long to ask. Decentralized financial systems are poised to replace the centralized financial systems, beginning with the crypto space itself. Decentralized exchanges have shown some level of reliability and despite being a relatively new concept, they have won the heart of many cryptocurrency enthusiasts.
Notable decentralized exchanges have shone light on what it feels like trading cryptocurrencies on decentralized feels like, amazing!—I guess you said that too!, escaping the hassles of copying hot wallet addresses and memos to enable the tracking of the deposits and also to ensure that they are correctly channeled to your personal profile on the exchange.
Decentralized exchanges provide a ‘blockchain-level’ security by allowing users exchange their assets without having to give up their private keys. Private keys give everyone a complete control over their individual cold wallets, security of the assets in these wallets are only compromised when the wallet owner give away their private keys, the recipient of the private key assumes ownership of the concerned wallet and the assets there-in. In centralized exchanges, the traders are not in possession of any private key, these keys are rather held by the exchange and thus they are in complete control of the assets in their possession. In cases of exchange scams, or accidental demise of the holder of this key (as seen earlier this year), the assets held in these exchanges are completely lost and there are little or no chances of the holders reclaiming their lost funds. This won’t be the case in a good decentralized exchange as wallet and asset ownership is not compromised in any way, traders retain the private keys to their individual wallets and simply connects to the exchange and enable their assets for trading.
The irregularities surrounding centralized Stable coins have also stressed the need for a centralized alternative such as DAI running on the ethereum blockchain. The need for decentralized solutions to current centralized options cannot be overstressed.
Outside the crypto space, users of traditional institutions such as banks and insurance firms have had to endure series of disappointments due to incompetence and irregularities of these centralized systems. Blockchain-based solutions(DeFi) provides a more advanced alternative with more automated, flexible, decentralized and relatively more secure options of running financial services.
DeFi could spell doom for traditional financial institutions. Source
Pull down the banks? Not so fast! decentralized financial system just like blockchain technology itself is still an emerging concept with couple of shortcomings which really needs to be fixed before they could be fit for mainstream use. The ethereum blockchain which is currently the leading platform for Decentralized financial system is faced with a couple of operational issues such as slow transaction speed, high fees and most importantly, poor scalability. Other smart contract blockchains which solve this issue still face some developmental barriers.
The time is now…I mean, the time to continue building and devising more workable solutions for the issues currently plaguing decentralized financial systems. DeFi taking over the traditional financial system or at least modifying it to a tangible extent is a question of ‘when’ not ‘if’. If the current pace of development continues then we could see DeFi infiltrate mainstream financial sector.