Breaking Down ‘Decentralized Finance’
Generally speaking, cryptocurrencies as a whole share a single goal. They aspire to make money and payments a commodity that is universally accessible to anyone. Regardless of where they live, they will be able to use it. This is where the Decentralized Finance (DeFi) or Open Finance movement comes in. It takes that promise to the next level.
DeFi largely includes digital assets, protocols, and smart contracts. In addition, it includes decentralized apps (DApps) that are built on a blockchain. The best way to think of DeFi is as an open financial ecosystem. One where you can construct a variety of small financial tools and services in a decentralized fashion. Since these are applications whose constructions are on a specific blockchain, you can combine, modify, and integrate them according to your needs.
Take a moment to imagine a global alternative to every financial service that you are using today becoming accessible worldwide. Whether it be savings, loans, trading, or insurance, imagine everyone having the luxury of accessing them. To take it a step further, what if they could easily do so with a smartphone and Internet connection?
Well, such a prospect is now possible on smart contract blockchains, like Ethereum. ‘Smart contracts’ are a type of self-executing contract with the terms of agreement residing in the lines of code. They are programs running on the blockchain that undergo immediate execution when certain conditions are met. These smart contracts allow developers to build more complex functionality that goes beyond simply sending and receiving cryptocurrency. These programs are what we ultimately refer to as ‘DApps’.
Many refer to the wide variety of products that associate with DeFi collectively as open finance. The reason for this being that it is a unique ecosystem. It is where blockchains, digital assets, and open protocols are integrated with conventional financial structures.
- Open Lending Protocols - This is a digital money lending platform whose construction occurs on a blockchain. Similar to a bank, users deposit their money. Moreover, whenever someone else borrows the digital assets, they will, in turn, earn interests. However, the similarities end when it comes to intermediaries. Filling their position of who dictates the loan terms are the smart contracts. These contracts also connect lenders and borrowers and are in charge of interest distribution.
- Stablecoins - Contrary to other crypto coins that possess a volatile value, stablecoins are blockchain tokens that hold on to a specific value. Most of the time, they are put into one of three categories:
- Fiat Collaterlized
- Exchanges and Open Marketplaces - Decentralized exchanges have peer-to-peer transactions of digital assets between two parties on the blockchain. There is no third-party involvement in these exchanges. Peer-to-peer marketplaces run by Ethereum have an exceptional amount of long-term potential. In the future, they could end up covering markets specifically for native digital assets and tokenized real-world assets.
- Issuance Platforms and Invest Management - This sector is special in that it covers a broad range of platforms. A large portion of issuance platforms are actively concentrating on the security token market. Over time, more players - especially institutions - are entering open financial markets. As this happens, these issuance platforms and investment management frameworks will both undoubtedly gain more momentum.
For all the skepticism, DeFi is nonetheless an innovative idea and its use cases are growing on the daily. It also helps in making things comparatively cheaper due to it lowering the overall cost of replacing middlemen and their big fees with smart contracts. Of course, this is something that will take time and a lot of experimentation to achieve.