For the last couple of years, DeFi has been the hottest topic in both FinTech and crypto, with many investors and developers believing it to be the future of finance. But what exactly is DeFi, and what makes it so significant?
What is DeFi?
DeFi, or “decentralized finance,” is a term used to describe any financial tool that eliminates the need for a centralized body. This means that there are no middlemen, third parties, or intermediaries involved. While this might not sound like much, the ability to cut out centralized bodies from traditional financial instruments such as loans and bonds has never happened before in economic history. DeFi allows people to trade, lend, borrow and manage their money in a way that provides complete independence. With DeFi, no institutions or organizations handle or control your money, meaning that ownership always stays with you, creating a more unrestricted financial experience.
DeFi technology is extremely new, having existed for less than ten years. The first DeFi projects to gain recognition were MakerDAO and Bancor, both released in 2017, which offered a lending platform that functioned without any centralized bodies whatsoever.
No more third parties
This is all made possible through blockchain technology. Blockchains allow people to manage their money securely without placing trust in any particular body or institution. Instead of putting your faith in a bank, credit card processor (like VISA), or payment gateway (like PayPal or Western Union), you can rely solely on the blockchain. This is a much safer option, as the code used to create most blockchains is open-source, which means anybody can view it. If anything were malicious or unsafe in the code, it would more than likely get picked up by the programming community.
When you use third parties, you have to place your trust in that entity’s integrity, but even the most well-known financial companies have experienced issues. There is no centralized economic body that hasn’t had to deal with some scandal in the past. But that problem is negated by Decentralized Finance.
Smart contracts play a massive role in DeFi. A smart contract is a computer-generated contract that executes upon being added to the blockchain. Smart contracts allow people to transfer value to one another under certain conditions, agreed upon by the parties involved, which are then enforced by the blockchain (rather than by a centralized body like a bank or broker).
Why should you care about DeFi?
Despite it being such a simple idea (engaging with finance without third parties), it has never entirely existed before. This is the first time in history where people can access traditional financial instruments (such as loans, bonds, and trading capabilities) without needing an intermediary, making DeFi perhaps the most revolutionary financial technology to happen in the last century.
Here are the primary benefits it offers:
When using DeFi services, you keep control of your money. Instead of handing your money over to an organization that you do not trust, you deal with the blockchain: an open, fully automated, and transparent network. When working with a centralized body, you have to place a great deal of faith in them, hoping they will take care of your money and that they have your best interests at heart. But with DeFi, you do not have to rely on faith because you have full knowledge of the inner workings of the blockchain and smart contracts you are using.
DeFi services are naturally less invasive than centralized financial tools (or “CeFi”). For instance, if you were to take out a traditional CeFi loan, you would likely have to provide the centralized body with proof of identity, bank statements and possibly even undergo a background or credit check. Not only would you hand your money to them as collateral, but you would also hand over extremely sensitive data.
However, if you were to take out a DeFi loan, you would not have to do any of this. With DeFi, nobody needs to see sensitive documents like this because no centralized body could assess or evaluate them. Everything happens via automation, so there is no requirement to pry. This makes DeFi a much more accessible and comfortable experience. Many people (rightfully) feel uncomfortable about handing over personal information to a corporation like a bank or lending provider.
Considering how DeFi allows people to exchange and handle money without an intermediary, it is significantly fairer. It means that fees are lower, as there is no third party to profit from people’s financial activity. It also gives more people access to financial instruments. Many people worldwide cannot engage with CeFi because they do not have official documentation or because institutions choose to ignore them. For instance, there are approximately 2 billion unbanked people, meaning they cannot access traditional CeFi services. These financial services are extremely useful for modern living, and the fact that so many people have been locked out from engaging in them is deeply unfair, however with DeFi, this all changes. DeFi allows more people to gain financial stability and take control of their lives.
DeFi is a game-changing technology in both crypto and FinTech, as it allows for the creation of projects and ecosystems that run without any third parties. They let people engage with traditional financial tools without relying on institutions and intermediaries, giving people more freedom and control over their economic lives. They also offer unbanked access to loans, bonds, and trading capabilities, providing them with life-changing financial instruments that many people often take for granted. Not only does DeFi have the potential to improve people’s lives for the better, but it has the potential to change the way contemporary finance is run as a whole. For the first time, centralized financial bodies are becoming obsolete, affecting the economic landscape in unimaginable ways.