‘DeFi’ seems to have come out of nowhere to be the new buzzword for blockchain enthusiasts. But what is DeFi, and what does it have to do with blockchain and crypto? Well, let us answer those important questions for you as we take a brief look at what the DeFi revolution is all about.
What is DeFi?
DeFi, or decentralized finance, refers to digital assets and financial smart contracts, protocols, and decentralized applications (dApps) built on decentralized blockchains, such as Ethereum. DeFi aims to create a financial system that is open to everyone and minimizes the need for individuals to trust and rely on central authorities, one of the central tenets of blockchain technology. In short, DeFi allows anyone to take part in a global financial system and look after their own financial affairs without the need for a bank.
Why do we need it?
Some argue that we don’t need DeFi, just as we don’t need blockchain technology or cryptocurrency, but its introduction would be hugely beneficial to millions of people across the globe. A decentralized, open-to-all financial system would allow those who cannot open bank accounts for whatever reason access to a global financial market, something that has potentially huge implications for countries where individuals or groups of people are restricted from accessing their own money by banks or governments.
How does it work?
DeFi apps and protocols are created on decentralized blockchain platforms, typically Ethereum, which use smart contracts to automatically carry out instructions. This ensures that no single entity is in control of the money that is being held or transacted through the app – the application merely facilitates the transaction, and all the funds are held by the user on their device. This is different to your banking app, where your bank holds your money and you give it instructions of what to do with it. The big difference is that your bank can say no to your instructions if it wants to, or can block you off from your funds entirely if it, or the government of your country, decides it has reason to do so. DeFi apps allow you to act as your bank, meaning you are 100% responsible for your actions.
What are the downsides?
The lack of a central authority means that, should something go wrong, you have very little means of rectifying it. For example, if you send money to the wrong person by accident, unless that person sends it back to you, it’s gone. Likewise, if someone manages to hack into your app or attacks the blockchain on which it sits and drains your funds, they’re gone too. Of course you can report certain actions to the police, and you might get lucky, but the chances of this are remote, given they crypto thieves are adept at covering their tracks and moving their funds through anonymous channels. There may be future developments that offer users a little more protection, but these will stop short of a central authority who can help you out, meaning that if you choose to store your wealth on a DeFi platform you should be prepared for such scenarios.
There is also the problem of criminals using DeFi platforms for nefarious activities, knowing that they can’t be watched. Unfortunately there is no real argument DeFi advocates can make against this, and it will be up to police forces to use their existing resources to prevent such activities from happening in the first place. Of course, blockchains such as Ethereum are not anonymous, meaning that finding one address in a chain can reveal the entire chain, but no criminal worth his salt will use an address more than once, potentially rendering these efforts worthless. This is one reason why the FBI said recently that cryptocurrencies were a “significant issue” that were only going to get “bigger and bigger”.
Blockchain’s Jewel in the Crown?
DeFi is one of the potential jewels in the crown of blockchain technology, but the current absence of a ‘killer dApp’ that combines usability with functionality and design means that it is yet to really take off. However, DeFi Pulse states that some $657 million is currently locked up in the various DeFi platforms, a number that has steadily been increasing as the space has grown since October 2017. Once that number hits the $1 billion mark, DeFi will begin to be talked about in much more serious tones, which will only lead to more exposure, and growth, in this potentially huge arena.