Imagine a world without banks and governments holding power over people’s money. A society where politicians, market makers and other VIPs have to follow the rules like everybody else. A reality where the people, no matter where and who they are or what they do, get to decide for themselves. Absolute. Financial. Freedom. Feels utopic, right? Well, thanks to DeFi, we may be closer than we think.
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Breaking DeFi down
DeFi is short for “Decentralized Finance”, which is a pretty broad term by itself. It refers to all the financial networks, platforms, applications and assets built on a blockchain that don’t rely on a single institution or organization to work. Instead, DeFi operates on smart contracts built on the blockchain and, therefore, can’t be deleted, modified or altered by anyone. All the information is safe in each of the network’s nodes.
Think of it this way: The economy of, say, England is a centralized system. The Bank of England (BoE) has absolute power over the GBP, its main currency. They decide the amount of money in circulation, the interest rates, the monetary base, even the value of it. The BoE can change the rules at will, and the people have no choice but to accept its decisions. It doesn’t matter if they agree. That one institution regulates the entire English economy. Centralization means a reduced group of people -the privileged elite- has full control.
DeFi, on the other hand, isn’t regulated by anyone at all. It runs on the lines of code programmed within the blockchain and agreed upon by its users. Some platforms even have governance systems that allow their users to vote for updates and changes. Decentralized finance gives power back to the people. DeFi is a synonym of true financial independence.
The DeFi ecosystem
Okay, enough theory. Let’s get to practice. There are many platforms and applications already working on Ethereum and Binance Smart Chain. These include:
- Decentralized exchanges (DEX): They are exchanging platforms that allow their users to swap one cryptocurrency for another. They connect directly to your wallet, so you don’t have to trust your coins to a third party and allow you to trade instantly. Most of them also offer investing instruments like liquidity pools and staking. Some DEX examples are Uniswap (Ethereum), Synthetix (Ethereum) and PancakeSwap (BSC).
- Lending: By using smart contracts, these protocols connect lenders and borrowers without the need for a bank to act as an intermediary and charge a commission on the profits. The most popular platforms like these are Aave and Compound (among others), both built on Ethereum.
- Tokens: DeFi enables many possibilities for cryptocurrency beyond Bitcoin. Stablecoins, on the one hand, are tokens that hold a 1:1 relation to a fiat currency. These tokens let you convert your money to crypto while avoiding the risk of volatility and providing the opportunity to invest or store it without the need of banks or brokers. However, there are also governance tokens: crypto native to a specific platform that grants voting rights within that platform. That way, the course to follow, possible changes and updates and any other decision-making is determined by the community. MakerDAO is a protocol that uses governance tokens and is also responsible for developing Dai, one of the most used stablecoins. You can check the value and market capitalization of these tokens in The Crypto App.
- Payment services: Derived from the former, DeFi provides an excellent network for P2P payment systems where the parties involved need no financial institution, credit card or anything other than an internet connection to process a transaction. To achieve this fast, secure and decentralized payment networks was the founding idea behind Ripple and Litecoin.
- Various investment instruments: Many protocols don’t specialize in a single function but offer different investment options in addition to the ones named above. These may include liquidity pools, staking, and yield farming, for example.
These are merely some of the applications in the DeFi landscape. Read an extensive list of platforms here.
Opportunities and limitations of DeFi
All in all, DeFi is revolutionizing the global economic system. Q1 2021 saw an unprecedented explosion of DeFi platforms adoption and, therefore, on tokens price. Yet all this is in very early stages and, although there is a lot of room for growth, it is still hard to understand sometimes. Let’s analyze both aspects.
DeFi provides not only an unmissable chance to make big money but also a way to democratize finance. Think of what happened with $GME and the stock exchange in January 2021: The powerful guys froze the market because it wasn’t going as they expected, making regular folks lose a lot of money. With DeFi, everybody has to follow the rules. There are no privileges and no bailouts. Everybody has access, and everybody follows the same rules. It is the most democratic form of finance.
However, although idealism is poetic and all, we do have to address big money. DeFi is still in its early stages. That means that many platforms and tokens aren’t getting the attention they should have, hence providing a good opportunity for a low entry. Aave token, for example, rose from $87 to $521 in merely more than a month. That is almost 600%! Many cases like these have appeared over the last few weeks, and many others could follow the same road.
On the other hand, this can also lead to dangerous risks. As they develop, it may be hard to distinguish the promising, useful projects from the scams or the flawed ones. There have been cases of tokens crashing to zero or platforms that closed overnight without any explanation. Be sure you do your research and learn where you are putting your money because no one will return it to you if you lose it.
There is also a matter to consider: incomplete decentralization. Many protocols, although mostly decentralized, have a centralization issue at some point. If you read our article about wrapped tokens, for example, you’d know that at a specific point of the process, you have to give a custodian control of your coins for them to mint the wrapped versions of them. A single entity holding all your money signifies a centralization risk. It doesn’t necessarily mean they will steal your money. It only means that a big part of the process depends solely on them. Like these, many other protocols have a “weak spot” hiding some centralization behind them, so be alert.
Take back control
DeFi is meant for you. Yes, you, sitting on your chair reading this article in your spare time. It enables you to achieve complete financial freedom without having to abide by the rules that a small elite has set. It is your chance to take back the power. But as Uncle Ben said to Peter Parker, with great power comes great responsibility. You and only you are responsible for your money in DeFi, so make sure you take all the necessary precautions and look after your security. That said, there is nothing more to tell you than “Welcome to the future of finance. You are early”.