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Çarşamba, 7 Aralık 2022
Çarşamba, Aralık 7, 2022
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DeFi 101

Is banking possible without banks? Is DeFi actually as decentralised as some say no?

2020 was a highly odd year for our planet. During 2020 when the Covid-19 virus made its presence felt intensely, we made efforts to adapt to the transforming order while facing some unprecedented global challenges. We also witnessed the start of a radical change in the finance world in 2020. Yes, we are talking about the rise of DeFi.

The history of DeFi, a type of finance, which makes use of blockchain technologies, to offer some typical financial services such as loaning, trading operations, and investments in the most transparent way possible, with no intermediaries; smart contracts and decentralised applications (dApps) date back to Bitcoin, developed in 2009 by mysterious inventor Satoshi Nakamoto. Bitcoin, which is the only ‘decentralised’ system according to some, is actively used in web services to eliminate the theoretical financial trust to central powers and produce alternative decentralised financial products with the blockchain technology which exhibits peer-to-peer architecture that enhances the online value transfer between partners without a reliable third party or any centralised financial institutions.

We can say that Bitcoin serves its mission by being the product of a ‘transparent money transfer product which eliminates the trust among individuals’; however, it is being considered that today’s complex finance too can have an equivalent in the decentralised world. If we are to talk about the time when DeFi literally made its name, we have to go back to the summer of 2020, known as the ‘DeFi Summer’.

The rise of DeFi

DeFi became popular when Compound, a borrowing and lending platform, released COMP which is a governance token, to reward its users during this process called liquidity mining. While such rewards, which are paid in COMPs, significantly increase the efficiency, they made available crypto staking or ‘yield farming’ strategies, which are more complex lending operations to earn higher income or get rewards and it made token owners to become part of the management. Some protocols, such as MakerDAO and AAVE adapting this situation to themselves led users to gravitate towards DeFi while increasing token prices and creating a boom in DeFi activity.

As the developments in DeFi promote an incredible amount of production of wealth for many, the crypto market became present in that period. DeFi’s locked value which was 700 million dollars at the beginning of 2020 rose to 15 billion dollars in the same year and with a significant value increase of 2100%, it went through a major expansion including lending, loaning, decentralised stock markets, yield farming, and insurances.

Why is DeFi different from traditional finance systems, and how?

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Having emerged as the combination of the first two letters of the words ‘decentralised’ and ‘finance’, DeFi literally means finance that is not affiliated with any centres. In other words, we can say the main idea behind the existence of DeFi is to eliminate central authorities, namely third parties, such as companies the traditional finance sectors are subject to, as far as possible. Actually, DeFi, rises against traditional finance with its similarity to the word ‘defy’.

DeFi, coming forward as an innovative and digital alternative that is suitable for today’s conditions, to the long lasting traditional finance system, makes it available for operations such as loaning and lending to be performed publicly in a safe environment while letting you convert your assets into tokens and making the transfer of your assets to any part of the world as fast as possible. DeFi eliminates the need for the expenses such as the office, clearinghouses, and bank employee salaries for the performing of the operations; because, DeFi is open to anyone that has an internet connection.

DeFi has many advantages too. The major ones are:

  • The only thing you need to do to benefit from what DeFi offers is creating a crypto wallet such as MetaMask for access. Also, DeFi does not require you to create any accounts or make any applications.
  • User privacy is key in DeFi. So you do not have to share your personal information, such as your name and email address, with third parties.
  • With DeFi, you do not have to get permission to transfer your assets, wait for long times for your transfers, or pay any fees, since it eliminates centralisation. Instead, you can transfer your assets anywhere and anytime you want.
  • Like all rapidly performed operations in DeFi, interest rates and rewards also get updated every 15 seconds, which is significantly faster than traditional finance systems, and these rates can be much higher than those common ones in Wall Street.
  • Centralised private companies usually abstain from offering transparency in their financial operations; however, anyone can view the operations with every detail in DeFi.

 The major feature that distinguishes DeFi from traditional finance systems is its approach to decentralisation. As mentioned above, all you need to do to keep your assets is to create a personal wallet in the DeFi system. However, in traditional finance systems, you keep your assets in institutions or organisations, such as banks. It means the source of trust is a public block chain that manages all financial operations in DeFi, the source of trust that manages all operations in traditional finance is a public administration that includes laws and licenced financial institutions. The fact that there is no entry barrier in DeFi means that anyone with programming skills can produce financial services and tools on public blockages.

On the other hand, operation and data are cenralised in a single area in centralised finance understanding and any attacks to this area may harm your assets, or even destroy them. It’s the exact opposite in DeFi; because, the DeFi system is open to everyone. What does the DeFi system being open to the public imply?

As data and operation on the DeFi system can be viewed by everyone, they are stored in multiple places and submitted to the approval of multiple people. It minimises the risk of your assets, transfers and data getting lost by reducing the error margin.

DeFi protocols

There are certain formats, codes and procedures needed for the management of crypto lending, loaning, and commercial occupations. These autonomous codes, known as ‘DeFi protocols’, designed to eliminate the problems in the traditional finance sector, appear in the smart contracts on programmable blockchains such as Ethereum.

The target of DeFi protocols is changing the current situation for more than 50% of the world population that does not have access to a bank account. And introducing more financial instruments can be possible with the further development of DeFi protocols. 

The last two years witnessed a significant growth, especially in the DeFi protocols that came to the fore. Until now, many DeFi protocols have become indispensable parts of an ecosystem, which is both gigantic, with vital tokens and projects, and complex. And thanks to the serious increase in the value of DeFi protocols, important opportunities have emerged for the enterprises in this area.

According to Statista data, there are many protocols that cause financial services among users to change, including fixed currencies in the DeFi market whose general magnitude reached 274 billion dollars in November, 2021. The most popular ones among them are:

  • MakerDAO 
  • AAVE 
  • Curve
  • UniSwap
  • Lido
  • Convex Finance
  • Pancake Swap
  • Compound

Stablecoins

Here, we should also talk about stablecoins. Stablecoins, known as the pegged equivalents of other currencies such as dollars in the digital world, enable income generation through crypto assets for investors in the DeFi market while mitigating the potential negative effects resulting from market volatility.

Investors, who are in search of more revenue rather than traditional fixed-rate investments such as saving accounts, money market funds or stocks, can digitise their funds to have revenues above DeFi market average. The easiest and the most secure way to do so is probably converting US dollars to USDC, which is the second most popular stablecoin after Tether with a 52.22 billion dollar market value, and re-investing it in DeFi protocols later.

But why?

If an investor invests ETH in the Compound protocol to earn interest, any decrease in the ETH value might balance all the revenue and this might end up with a loss for the investor. But, if the same investor uses a stablecoin such as USDC, the value of the essential asset remains the same and the yields are not affected by the volatility in the crypto market.

The controversial 'decentralisation'

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But, DeFi protocols and how ‘decentralised’ DeFi actually is, highly controversial. Although DeFi does not have a centre as opposed to traditional finance, experts say that this is in fact not the case. There is a centralised company behind the biggest stablecoins, actually.

Eva Kaili, Vice President of the European Parliament, stated that DeFi is ‘completely decentralised’ by its definition, meaning that ‘nobody can control or manipulate a blockchain.’ She emphasises that many DeFi protocols that claim to be decentralised aren’t actually decentralised. ‘We need to have safeguards to understand who is a developer, who controls that, what are the keys, if somebody can change the code or not, where is the jurisdiction. We should make sure we understand how it works.’ she says.

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The FinTech case #2: Private wealth management and DeFi 101

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Aposto Tech

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