What is DeFi?
DeFi stands for decentralized finance, a broad category of peer-to-peer financial applications that are being developed on top of programmable blockchains. The principles that underpin DeFi align with the overarching goal of decentralization that is a defining characteristic of blockchain technology.
What is Decentralization?
Decentralization means eliminating centralized intermediaries who currently facilitate most types of exchange in our society and instead enabling peer-to-peer exchanges of goods implemented by immutable, secure protocols built on blockchain and recorded on public ledgers.
As an example, the centralized intermediaries that DeFi aims to eliminate are banks and the traditional finance system. If blockchain technology can enable secure, verifiable transactions between individuals, it will make banks and their exploitative practices obsolete.
DeFi vs. Traditional Finance
DeFi aims to improve upon and eventually eliminate or completely transform traditional financial systems (TradFi) so that all financial exchanges that occur across the globe adhere to the principle of decentralization. When this goal is achieved, it will mean a more equitable distribution of wealth and greater access to financial opportunities for anyone in the world with an internet connection.
Beyond this high-level goal, DeFi improves upon current financial systems in many more tangible ways. TradFi technology can be slow, clunky, geographically restrictive, and somehow in the year 2021, banks still have limited operating hours. Many of these institutions have been slow to adopt new technology due to a lack of competition and innovation.
DeFi aims to revolutionize finance in the same way the Internet revolutionized communication: the Internet transformed the way human beings interact and exchange information. DeFi will radically alter the way human beings are able to extract value from their labour and exchange that value using decentralized, peer-to-peer global financial infrastructure.
How Can DeFi Build a Global Decentralized Financial System?
Conceptually, this all sounds great, but you might be wondering how DeFi will accomplish such a profound transformation of the way we express and exchange value. Right now, the primary mechanism for achieving the vision of DeFi is through “smart contracts.”
A smart-contract is automated code that enacts a set of instructions that are permanently visible and verifiable on the blockchain. Once deployed, they are irreversible and unalterable, ensuring an extremely high degree of security and reliability. Ethereum and networks that are EVM (Ethereum Virtual Machine)-compatible enable anyone to programmatically control digital value through smart contracts.
Smart contracts can easily replicate swaps, options, loans, bonds, and many other financial instruments which are traditionally executed by banks and other centralized institutions who charge hefty fees and throttle the amount of interest that individuals can earn on their assets.
In DeFi, anyone can write smart contracts to create new financial instruments such as money markets, exchanges, and asset management solutions. The existing DeFi ecosystem is vast, but we haven’t even scratched the surface of what is possible with this technology.