DeFi is the acronym for Decentralized Finance, which in Spanish means decentralized finance. This name is used to define a financial ecosystem that has been built on the blockchain and whose main characteristic is that it is the users themselves who manage all the actions, without having to go through a trusted third party (such as a bank or an asset manager). investments).
DeFi or Decentralized Finance (Decentralized Finance, in Spanish) is the name that is defining a great trend that is taking place around the tecnología blockchain in recent years.
DeFi seeks to develop traditional financial services, but with a greater degree of transparency and decentralization. These services, as if they were Lego pieces, can be combined with each other, in order to develop a whole ecosystem of small tools that together form a great solution for finance that eliminate the need for centralized financial financial institutions.
That is the idea that has driven the creation of the term “DeFi”, and the one that has led its evolution to the current point. In fact, nowadays it is impossible to ignore the huge impact that DeFi has on the crypto world.
DeFi, the idea that is changing the financial world
Imagine a world where anyone could create transparent, fair and efficient financial products, causing banks, big financiers, lenders and insurance companies to fade into the background, or better yet, become completely unnecessary and disappear. A world where anyone can freely interact with these products.
Well, this is what decentralized finance aims for. In other words, they want to convert the centralized finance structures that we have now into decentralized structures, without trusted third parties, executed on smart contracts or smart contracts, within a blockchain where a written and unalterable record of each action carried out is reflected in a transparent way.
The impact of a trend like this is gigantic. We are only in its early years and already the creativity of the global community is shaping alternative versions of almost all existing financial products.
Imagine that you have the need to obtain a loan to undertake. Instead of going to a bank, you can go to a DeFi platform and apply for a loan. Said loan has conditions (saving the technicalities) quite clear and transparent. All this thanks to the fact that said loan will be controlled by a Smart contract public and immutable.
Not only that, All actions carried out on the platforms are visible and immutably recorded on the blockchain as well.. Perhaps you do not have the knowledge to verify the reliability of the DeFi service, but due to its transparency feature, thousands of eyes will be able to analyze and question it, warning of its malfunction if it were. And in the future, given the impact of this technology, children will surely be taught to read transparent smart contracts in school.
Thanks to DeFi, you will not need to be banked, you will not need to carry dozens of papers, stand in lines to deliver them and wait weeks for a response. Instead, from the comfort of your sofa, with your smartphone you can do the whole process receiving the money in no time.
However, DeFi can be much more, it can become the vehicle for the entire world economy and finance to begin to decentralize. The vehicle that opens the doors to international investments with lower costs, faster and with higher levels of trust and transparency. A vehicle so that unbanked people can access services without the need to go through banks, having the same conditions to evolve personally in their development.
Origin of DeFi
If you are one of those who think that DeFi originated with the birth of Bitcoin, you are right. Bitcoin it was the world's first DeFi platform. But the origin of the idea is much older.
Nick Szabo He was aiming, perhaps unknowingly, at the birth of DeFi when he presented his idea of smart contracts in 1995. That is 13 years before the creation of Bitcoin, an idea ahead of its time.
However, it was not until the arrival of Ethereum in 2014, that a radical change could be given to this idea. ANDthereum and its smart contracts allowed developers to create anything they could imagine on a blockchain. And what started with an experiment is now becoming a movement of its own: a decentralized financial ecosystem that operates billions of dollars every month.
An ecosystem that during the years 2018 and 2019 maintained a constant development, and during the first months of 2020 it had an unprecedented growth. Reaching the point that it has revalued blockchain projects by creating bridges between traditional finance and cryptocurrencies.
Thanks to this work, we can now count on liquidity markets, loan systems and Decentralized exchanges (DEX), all this being just the beginning.
DeFi Features
Now that we know the concept, its origins and the differences between digital financial models, let's know what the characteristics of DeFi are.
- They work based on blockchain technology and smart contractss.
- They are very safe since they use powerful cryptographic techniques to ensure that the platform, access and use thereof can be carried out only by authorized persons.
- They have high levels of decentralization. DeFi's greatest potential is its high level of decentralization. That is, they have the ability to act without the need for a bureaucratic chain to impose itself over the functions of the platform.
- No trust in third parties. This means that any action on a DeFi platform is direct between the user and the platform itself. Trusted third parties are unnecessary because that task will be performed by the blockchain. It is this structure that will keep track of everything securely and immutably.
- Transparent Another great feature of DeFi is its transparency. Being built on free software, each line of code of the platforms is auditable, also the mobilization of resources, because they all take place on the blockchain.
- Without Borders. Access to a DeFi platform is borderless. You can be in any country in the world and access its services without inconvenience.
Pros and Cons of DeFi Technology
Of course, like all technology it has its pros and cons.
Pros
- Enables access to financial services for millions of people who are not banked. This is undoubtedly a golden opportunity to bring development and financial freedom to those who for different reasons have not been able to enjoy these services.
- It makes international financing of companies and projects much easier. DeFi platforms can be tailored to the needs of a target audience to bring development and investment where it is needed. And those investments can come from anywhere in the world safely.
- Create a new point of economic diversification and development. In fact, DeFi can mean an important point of economic development in the medium term due to the enormous economic potential of cryptocurrencies such as Bitcoin.
Cons
- Security continues to be a point to polish within DeFi platforms. Although the blockchain has proven to be a very secure technology, there are still many things to improve, especially with the level of security and security auditing of smart contracts. A failure in a smart contract means a failure in the platform, as demonstrated The dao.
- Action protocols in the face of cryptocurrency volatility. Many DeFi platforms have created operating mechanisms that guarantee their economic stability against the volatility of cryptocurrencies. However, these mechanisms often seem insufficient. Or they simply do not fully protect the ecosystem against strong fluctuations. A situation that leads to millionaire losses. A case of this type is MakerDAO y DAI, whose fluctuations and corrective actions have shown that decentralization and poorly adjusted action protocols can often be a weakness for these platforms, if they are not handled correctly.
DeFi and FinTech: What are their differences?
Now we have in our hands three finance models that to some extent have the same common goal, which is to offer us powerful financial tools to help us strengthen our finances and portfolios. However, the way in which they achieve this is completely different for each of the models. We are talking about traditional finance, the new FinTech and of course DeFi.
We already know traditional finance, the centralized model, highly dependent on banks, convoluted and complex for the vast majority of the world's population. We are talking about a model that we see that finds it difficult to innovate and whose tools, in many cases, do not work.
From the attempts to renew and improve that old system, comes our second model, the FinTech (Financial Technologies - Financial Technologies). We are talking about an attempt to create a digital finance system that allows reaching a larger population, that is fast, efficient, cheap, global and above all easier to manage. Since the 90s and the beginning of the new millennium, FinTechs have risen as the pinnacle of financial technology and it seemed that they would be the next evolutionary leap in global finance.
However, that was left behind with the birth of Bitcoin, the arrival of Ethereum and the first DeFi systems. The fact of being able to build decentralized, safer, more universal and borderless finance changed the rules of the game, not only because of how it works but also because of the possibilities of DeFi.
How can we differentiate them?
- A FinTech is a centralized entity, built on software and with controlled and objectionable environments. On the other hand, a DeFi deploys its software on a decentralized blockchain.
- The contracts of a FinTech are contracts that follow the legal construct that we all know. While in DeFi those contracts are set equal for everyone, the heart of a DeFi and its services are the smart contracts on the blockchain that we can view and audit freely.
- The approval decisions of a FinTech are tied to a bureaucratic chain, long or short, that means time that as users we lose waiting for a response to our requests. On the other hand, in a DeFi the chain is reduced between you and the person who will give you the credit, sometimes, the chain does not even exist, because the approval is carried out automatically if you meet or exceed the requirements that the platform asks for. access their services.
- A FinTech uses banks and the entire traditional finance structure to get you the resources you request. That means that yes or yes, you need to be banked and registered in the system to participate with certain guarantees. It also means that that money can be censored or limited if they choose. In DeFi, this is not something you need to worry about, you don't need to have a bank account, just one cryptocurrency wallet where to receive your funds and the rest you have freedom.
Given this vision, it is quite clear that a FinTech is a digitized financial entity. Some well-recognized FinTech projects worldwide are Revolut or Paypal, to name just a few.
Potential DeFi use cases
Now, What good are DeFi for us today? What uses can we give them? Well, first of all, DeFi serves as a financial bridge between the wealth of cryptocurrency holders and a world of financial services, which can be provided by using that wealth to generate more wealth with it.
That said, among the potential use cases of DeFi we can mention:
- Decentralized lending systems: one of the main use cases for DeFi today. The system is simple: if a person wants a loan and wants to use his cryptocurrencies as collateral or guarantee, he can do it without problems. The system works in a very similar way to FinTechs or traditional finance. But DeFi tends to offer better interest terms and loans are generally approved almost instantly. Gone are the hours in the bank, sending digital documents and waiting days for a response, with DeFi it is enough to interact with the DApp, make the required guarantee deposit and you will have in your possession the money you have required in loan, and all in a few minutes.
- Decentralized markets: Another use case for DeFi is decentralized markets. Creations such as decentralized exchanges (DEX), investment pools, financial derivatives, staking systems, prediction markets, and more are possible thanks to DeFi.
- Payment systems: Another use that is given to DeFi is payment systems. The characteristics of these platforms allow them to be a trusted bridge to process payments from different blockchains, making use of an external, decentralized and autonomous infrastructure.
- Banking and insurance services: Another use of DeFi is to offer “banking” type services without being exactly a bank. For example, there are DeFi protocols that allow their users to make a certain investment. But after a while, you can receive this investment with a profit margin, and all thanks to the interest that it has generated. But not only that, but there are also systems that allow the issuance of stablecoins, as well as digital identification and financial insurance systems.
At this point it is clear that the potential of DeFi to offer services and solutions is varied, as varied as the inventiveness of the people who develop such systems.
Risks to consider in the DeFi world
Now, in DeFi not everything is perfect. In fact, the truth is that there are risks that it is good to know before entering fully into this world just like that. Among these risks we can mention:
Complex contracts and platforms to understand and use
First, the DeFi is not for everyoneNo matter how much they want to show otherwise. If you enter a DeFi DApp and try to carry out an operation, you will surely see that in the midst of all this there are concepts that may seem strange to an average person. Not only that, DeFi contracts and application web explanations as well as the smart contract of such applications may seem like a lost language of the world to most people.
That said, it is good that you are aware that although DeFi offers great possibilities, you should know what you are participating in and investing in, and that involves learning and understanding what the platform does, how it does it, and what tools you have at your disposal. provision. All this, in order to avoid painful situations such as the loss of your investment.
An incomplete decentralization
Second, DeFi applications, even though they run on a blockchain like Bitcoin, Ethereum, EOS o TRON, does not mean that they are fully decentralized. Generally, many DeFi protocols and applications have some point of centralization that allows them to have a certain degree of control for situations in which immediate intervention is warranted. An example of this is MakerDAO and its DAI stablecoin.
While MakerDAO functions as a decentralized entity, the figures behind the development of the protocol have what could be called a "Panic Button" called "Emergency Shutdown". This functionality of the protocol allows to close all the operation of MakerDAO and DAI to prevent investors from suffering serious losses due to a problem in the collateralization of the protocol. You can imagine that if there are features like this in MakerDAO, other projects will also have a similar or even greater feature.
But why is this a risk? If you think about it a bit, functions like these can be exploited by malicious actors inside and outside the protocol to cause damage within it. It is also a risk because many DeFi sell themselves as fully decentralized, when the reality is very different. A problem that is aggravated if we add the appearance of DeFi protocols that are nothing more than a scripted scam.
In short, you know the project in which you participate well, you know its functions, but above all, you know the community that maintains it. A transparent community will hide nothing, such as the case of MakerDAO that made public the information about “Emergency Shutdown” and the reasons for its creation. If you suspect something like that, be especially vigilant with new and little-known projects.
Introductory course to DeFi
Medium levelTime to update. Traditional finance has changed, discover the revolutionary ecosystem of decentralized finance (DeFi).
Security is not foolproof
While it is true that blockchain security is excellent, it is also true that it is not infallible. We see the best example of this in the various DeFi projects that have suffered from security problems related to their smart contracts and that have led to theft of millions of dollars from their platforms. Platforms like dForce, Uniswap, Balancer, Bancor, bZx and Synthetix are just some of the victims of the most notorious hacks in this sector.
The problem is even more serious, because the security of smart contracts depends on two factors. First of all, it depends on the good coding and construction of them by the developers of the DeFi protocol. Thus, a good project codifies, reviews and audits its smart contracts constantly. That way, if it detects an error, it is corrected quickly without delay.
Second, security too it depends on the good programming of the functions that make possible its direct operation in the blockchain. For example, a security issue in a function of the EVM that affects these smart contracts, and automatically their security is at risk. The problem with this last point is that security no longer depends so much on the developer of the DeFi protocol. Instead, it's up to the blockchain developers, and in case it can't be mitigated properly, you'll have a serious security issue.
Yes, it sounds like a horror story, and that a technology that is assumed to be ultra-safe can have these problems is surprising. However, they are real problems, in fact the function DELEGATE CALL of EVM, was the cause of an attack that occurred at Parity wallets in 2017.
The danger of scams
If you have been in the crypto world long enough, you will surely remember the ICO Boom of 2017 and 2018. And you will also know what it meant to many: million-dollar losses and scams everywhere. At this point, DeFi is starting to go through the same process. In fact, there are hundreds of projects that disguise themselves as DeFi to scam those who fall into the trap of making quick and easy money.
In the midst of the DeFi boom, which is in vogue, it is not uncommon to see how platforms look for an easy way to develop their ideas. We see an example of this in dForce, who simply copied the protocol of Compound (version 1) to launch your platform. As a result, the dForce platform fell victim of a security breach that they did not detect and had great losses.
As this situation many more can occur, copy a smart contract, change some things and launch a service with the sole purpose of scamming those who fall into the trap. It's something that happens more often than you might think, and one of the reasons you need to be very vigilant when you enter the DeFi world.
DeFi platforms today
Currently, the development of DeFi platforms is gigantic. Bitcoin and Ethereum collect the largest and most important. Only between these two projects already 70% of the capitalization of cryptocurrencies is controlled, that is almost 200 billion dollars.
That has attracted many companies to start exploring the creation of tools, DeFi, some with more success than others, but among them we can mention:
- BISQ, a P2P exchange protocol built especially for Bitcoin and completely decentralized.
- RSK, a protocol and set of services identified as RIF OS, a complete development platform that includes smart contracts, digital identity, decentralized storage, instant payments, cross-chain bridges, integrated payment system, decentralized communications, and generation of decentralized markets.
- 0x, a protocol for building decentralized P2P exchanges that works on top of Ethereum.
- Bancor is a token exchange system built on Ethereum.
- Compound, is an investment pool protocol with options for lending, yield farming, and liquidity mining that has gained great relevance during 2020 to the point of displacing MakerDAO for two weeks as the DeFi of the highest value.
- Kyber, a swap protocol for integrating exchange functionalities in applications with cross-chain operations.
- MakerDAO and DAI, one DAO and one stablecoin designed to facilitate the creation of financial applications built on Ethereum.
- Augur, a protocol for creating prediction markets.
- Corners, a DEX of stablecoins.
This is a small list of some of the most important DeFi applications that exist today. Naming them all would be a daunting task due to the diversity of tools that exist today. But those mentioned here have earned a place of honor due to their seriousness, commitment and active development.
Given this, there is no doubt that DeFi and its different applications will be increasingly important in the future. After all, we are just exploring these tools and acknowledging their scope.