If you ask several crypto enthusiasts what DeFi means, you may get a broad range of answers. The popular versions would be “the biggest financial revolution in the last 200 years”, “blockchain-based financial software” or “a solution to the failures of traditional finance.”
We can narrow it all down to 2 basic definitions.
Depending on the context, Decentralized Finance can refer to:
Simply explained, DeFi means putting all the existing financial services on blockchain.
For many people, Decentralized Finance, cryptocurrency, and FinTech sound synonymic. All three terms refer to fast and hassle-free global payments. But there are some important differences.
The Open Finance ecosystem relies on decentralized financial apps (DApps). In the vast majority of cases, such Dapps stand on the Ethereum platform, the pioneer of the sector. As all these applications root in the same blockchain and operate under the same set of rules, they can interact with each other. Therefore, the users can combine, adjust, and customize various DApps to better suit their needs.
It’s like Lego: you construct your financial reality clicking blocks together. Though the blocks may differ in color and design, they are always compatible with each other.
To understand how a DeFi app works, let’s juxtapose it with a centralized payment service, like Transferwise or PayPal. Both aim at making money transfers fast and cheap, compared to the traditional banking system — costly and slow.
Let’s consider a real-life example. Alice sends $100 to Bob living in another country. The company, providing the service, takes these $100 from Alice’s account in Bank A. Bob receives this amount from the company’s account in Bank B. This scheme allows the guys to move money faster and reduces transaction fees.
Ok, everything looks rather affordable and convenient. But there are a few important things to keep in mind. First of all, Alice has to trust the company she uses. Second, she depends on the service provider to approve and execute her transaction. As we know, each payment undergoes a screening process. In this respect, PayPal (and similar FinTech companies) are not different from banks. If Alice’s transaction seems “suspicious”, her funds may be locked. It will take some time to solve the problem with the company, depending on how responsive their customer service is.
Besides, Alice may be unable to send money to Bob if he lives in a country where the payment system doesn’t operate. Or if her card issuer (another centralized organization) is experiencing some technical problems.
Now, let’s consider a decentralized payment scenario, where Alice uses a DeFi product to send her friend $100. For it, she can opt for the Dai stablecoin, a “digital dollar”. Stablecoin is a hybrid between crypto and fiat currency that matches the benefits of both.
In this case, Alice does not depend on any company or bank to approve and perform her transfer. She pays a fee to the Ethereum miners who validate her transaction and add it to the blockchain. This fee is tiny compared to what Alice would pay to a money transfer service like PayPal. Also, the funds will reach Bob very fast. Normally, it takes between 15 sec and 5 min to process a transaction. If the network is busy and Bob needs money badly, Alice can always speed things up by increasing the standard gas price.
The decentralized finance system offers various types of products. The list includes:
Several properties make DeFi apps stand apart from other financial innovations:
Here is an incomplete list of benefits DeFi has to offer:
Most importantly, unbanked people all over the world get access to financial products and services. It becomes easier to send, receive, loan, and borrow money. Those unable to afford a traditional insurance contract now can protect themselves from emergencies.
There is no central body (like a government) to control and guide your investment policy. Also, more people get access to the forms of investments they couldn’t afford before. For instance, a tokenized piece of art or a building can be owned by many individuals, each holding a fraction of the asset.
You can make your money work by depositing them on a landing platform. Other people will borrow it and you will get your interest. Therefore, you can avoid holding your money in banks. This is a big advantage, especially if you live in a politically unstable area and don’t trust centralized institutions.
As you see, Decentralized Finance takes the dreams of Satoshi Nakamoto to a whole new level. Just imagine every smartphone user having a decentralized alternative to every financial product.
It’s the future we are looking forward to.