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De-Fi: The future of Finance or just a bubble?

Updated: May 1, 2021

Massive changes and shifts have often occurred in humanity's history, and some of them have totally altered the environment and the way we see it: modifying whole markets, generating new possibilities while eliminating others, and making significant changes in our everyday lives.

One of the most significant in the modern century has been the internet and digitalization, which has spawned a slew of other possibilities.

The question is, what is going to be the next big thing that will really change the game? DeFi could be the answer.

Decentralized Finance (DeFi) is a form of blockchain-based finance that does not rely on central financial institutions such as banks and exchanges to provide conventional financial instruments, instead of relying on smart contracts on blockchains.

The DeFi market has gotten a lot of publicity and speculation recently, thanks to the crypto bull run fueled by the massive growth of Bitcoin and Ether, but it's still growing insane percentages and hitting a valuation of $ 61 billion; the question is: "Is DeFi a bubble?"

How DeFi works? The DeFi ecosystem is based on two major concepts:

  • DeFi DApps (Decentralized Applications): applications that perform financial functions on blockchains and enable users to transact directly with one another through smart contracts.

  • Smart Contracts: computer programs that enable a contract or agreement to be automatically executed without the use of intermediaries.

The Ethereum blockchain, founded in 2013 by Vitalik Buterin, is the most well-known network for running smart contracts in DeFi today. It is currently the most widely used blockchain, with the native cryptocurrency Ether (ETH) ranking second in terms of market capitalization. Ethereum is an ideal foundation for DeFi because:

  • No one owns it, and anybody can use the smart contracts it contains.

  • The Ethereum blockchain is used by the majority of DeFi products, which ensures that all of the items can work together seamlessly.

  • Cryptocurrencies are built into Ethereum, a sharedledger. This permits to keep track of transactions and ownership.

  • Most products built on Ethereum will never take custody of your funds, allowing complete financial freedom.

MakerDao, founded in 2014 by Rune Christenson, is one of the most well-known DeFi protocols. MakerDAO's stablecoin-based lending platform is widely regarded as the first DeFi framework to see widespread adoption. Users can borrow Dai, the platform's native token, which is pegged to the US dollar. MakerDAO aims to preserve the secure value of Dai in a decentralized and autonomous manner through a series of smart contracts on the Ethereum blockchain that regulate the loan, repayment, and liquidation processes.

Uniswap, a decentralized exchange that operates on the Ethereum blockchain and allows for the exchanging of hundreds of different digital tokens distributed on the Ethereum blockchain, is another example of a DeFi protocol. Uniswap's algorithm incentivizes users to form liquidity pools for the tokens by issuing trading fees to those offering liquidity, rather than relying on centralized market makers to fill orders. While a development team creates applications for Uniswap, the platform is ultimately controlled by its users. There is no one to verify the identity of the people who use Uniswap since it is run by no centralized party.

What’s the problem solved? The financial world as we know it today is far from being perfect, and many issues must be addressed:

  • A few privileged people make key decisions that affect billions upon billions of people.

  • Banking scandals involving millions of dollars.

  • When it comes to international finance, there is a lot of inefficiencies.

  • Inequitable access to financial services, with many people being unbanked.

  • New entrants face high entry barriers. Massive sums of money are needed to join the industry, which limits the sector's ability to innovate.

  • The financial system is founded on inefficient and outdated structures.

That is why we need something new and improved to address some of these issues: Decentralized Finance.

Defi owns to create a modern financial system using the power of technology, decentralization, and blockchain to allow access to the most well-known financial services (payments, lending and borrowing, trading) in the most fair, efficient, and open way possible:

  • Fair: everyone with a browser and an Internet connection can use these services, and everybody is treated equally (no need for document identification, nationality or income statement).

  • Efficient: regardless of where you are in the world, most operations can be settled in a very short amount of time with very little human intervention.

  • Open: everyone can contribute to the ecosystem.

To add up, everything done is transparent and visible on the blockchain. Naturally, DeFi has his own issues to deal with:

  • Defi gives the consumer more responsibility: it is the investor's responsibility to protect and maintain his money.

  • Extremely high gas fees: due to rising volumes and demand on the Ethereum blockchain, gas fees have skyrocketed in recent months.

  • Hacks: Using such DeFi protocols that are new and unreliable is very risky.

  • Mortgages and loans are essential elements of conventional finance that are highly difficult to incorporate in a DeFi setting.

Conclusion Despite the challenges that DeFi has to overcome, it is undeniably a game-changer and a truly unique breakthrough that, if it continues to evolve at its current pace, will inevitably affect conventional finance, forcing major players such as banks and fintech firms to begin adopting this protocol.

Who knows if one-day DeFi will simply be renamed Finance?

by Andrea Marsili

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