What is DeFi or Decentralized Finance?

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, the idea that is changing the financial world

Imagine a world where anyone can create transparent, fair, and efficient financial products, relegating banks, large financial institutions, lenders, and insurers to the background, or even making them completely dispensable. A world where anyone can access and use these products freely, without barriers or intermediaries.

This is the vision that drives decentralized finance, known as DeFi. Its goal is to transform the centralized financial structures we know today into decentralized ecosystems, without trust in third parties. All this is based on the smart contracts or smart contracts, which operate on a blockchain where every action is recorded in a transparent, immutable and auditable manner by all.

A financial revolution

The impact of this financial revolution is enormous. Although we are still in its early stages, global creativity is giving life to alternative versions of almost all traditional financial products. For example, if you need a loan to start a business, instead of going to a bank, you can apply for a loan on a DeFi platform. This loan is governed by a public and unalterable smart contract, which ensures clear and transparent conditions for both parties.

Furthermore, all transactions carried out on these platforms are permanently recorded on the blockchain and visible to everyone. You may not have the technical knowledge to assess the reliability of a DeFi service, but thanks to its transparency, thousands of users can monitor, analyze, and report any anomalies. In fact, it's likely that in the near future, education will include teaching how to understand these smart contracts.

With DeFi, you don't need to be banked, skip endless paperwork, wait in lines, or wait weeks for a response. From your smartphone and in the comfort of your home, you can complete financial processes and receive funds almost instantly.

Decentralizing global finance

But DeFi is much more than that: It has the potential to be the engine that decentralizes the entire global economy. It can open the door to faster, cheaper, and more secure international investments, with unprecedented levels of trust and transparency. Furthermore, it offers unbanked people equal access to financial services, allowing them to grow and develop without relying on traditional institutions.

Ultimately, decentralized finance is redefining how we think about money, credit, and investment, bringing financial innovation directly into people's hands.

Origin of DeFi

If you think decentralized finance, or DeFi, started with the arrival of BitcoinYou're right to a certain extent. Bitcoin was the first platform to enable the idea of ​​a financial system without centralized intermediaries. However, the concept of DeFi has roots that go back much further.

In 1995, Nick Szabo He introduced the idea of ​​smart contracts, a revolutionary proposal for its time. These automated contracts could execute terms securely and transparently without the need for intermediaries. This idea was fundamental and laid the groundwork for the future development of decentralized finance, although at the time, blockchain technology did not exist to fully implement it.

But it wasn't until 2014, with the arrival of Ethereum, that this vision took tangible form and evolved rapidly. Ethereum It allowed developers to create decentralized applications (dApps) using smart contracts that could handle any type of financial or functional logic they could imagine. What began as an experiment grew into a global movement that now handles billions of dollars each month.

During 2018 and 2019, the DeFi ecosystem showed steady growth, laying solid foundations in infrastructure and technologies. But it was in 2020 that its expansion exploded, reaching a turning point that strengthened the relationship between traditional finance and cryptocurrencies. This process has increased the value and relevance of many blockchain projects and created bridges for more fluid collaboration between the two worlds.

Today, thanks to this advancement, we have liquid digital asset markets, decentralized lending platforms and Decentralized exchanges (DEX) that operate without intermediaries. These tools are just the beginning of a financial revolution that promises to completely transform how we manage money and investments.

DeFi Features

Now that we understand the concept, origins, and differences between digital financial models, it's important to understand the main characteristics that define decentralized finance, or DeFi.

First, DeFi works thanks to technology blockchain and smart contracts or smart contracts. These contracts are programs that run automatically on the blockchain, eliminating the need for intermediaries and ensuring that the rules are strictly followed.

Second, DeFi platforms are highly secure. They use advanced cryptographic techniques that protect both the platform and access to it, ensuring that only authorized users can transact or use the services.

A fundamental aspect is its high level of decentralizationThis means that DeFi operates without relying on a central entity or bureaucratic chain to control or influence its operations. Decision-making and execution of actions are distributed among a network of participants, reducing risk and avoiding single points of failure.

A transparent system

Also, DeFi works without trust in third partiesEvery interaction is direct between the user and the platform, without the need for intermediaries to validate or supervise transactions. The blockchain is responsible for recording everything securely and immutably, guaranteeing the integrity of transactions.

Another key feature is the transparencySince they are built on open source software, anyone can audit the code of these platforms. Furthermore, all transactions and fund movements are publicly recorded on the blockchain, allowing for verification of proper functioning and detection of potential irregularities.

Finally, DeFi knows no borders. Anyone, anywhere in the world, can access its services without geographical restrictions or complex legal barriers, thus democratizing access to financial products.

In short, decentralized finance combines security, transparency, accessibility, and autonomy, offering a more open and fair financial system for all.

Pros and Cons of DeFi Technology

Like any technological innovation, decentralized finance (DeFi) presents both advantages and challenges that are important to understand in order to fully grasp its impact on the financial world.

Professionals

One of the biggest benefits of DeFi is that opens access to financial services to millions of unbanked peopleThis represents an invaluable opportunity to bring development and financial freedom to those who, for various reasons, have been unable to access traditional banking services. Thanks to DeFi, these people can participate in the global economy more equitably.

In addition, DeFi platforms They facilitate international financing of companies and projectsThis ecosystem adapts to the specific needs of different communities and geographic areas, allowing investments to arrive quickly and securely from anywhere in the world. This boosts local economies and promotes global growth.

Another positive aspect is that DeFi creates new avenues for economic diversification and developmentThe economic potential of digital assets like Bitcoin has driven this movement, which in the medium term could represent a significant growth driver for various sectors, generating opportunities for entrepreneurs and developers around the world.

Cons

However, security remains an area that requires constant improvement in DeFi platforms. Despite blockchain technology being very resilient, smart contracts —the core of these platforms—can present vulnerabilities. A bug or error in a smart contract can compromise an entire platform. A notable example was the incident with The dao, which highlighted the risks when poorly designed code is exploited.

On the other hand, the high volatility of cryptocurrencies remains a major challenge. Many DeFi platforms have implemented mechanisms to maintain economic stability in the face of these sudden changes, but these systems are sometimes insufficient. The lack of adequate protocols or their poor design can leave the ecosystem vulnerable to significant losses. Cases like this one MakerDAO and its stablecoin DAI They show how fluctuations can test the decentralization and effectiveness of these mechanisms, demonstrating that inappropriate control or slow response can seriously affect the stability of the system.

DeFi and FinTech: What are their differences?

Today, three financial models coexist. While they share the goal of offering tools to improve our finances and portfolios, they do so in very different ways. These models are traditional finance, FinTech, and DeFi.

Traditional finance is a centralized model, heavily dependent on banks and other institutions. This system is complex and difficult to access for a large portion of the world's population. Furthermore, it tends to lack innovation, and many of its tools don't work well for everyone.

The FinTech (Financial Technology) model emerged from the need to renew this system. It seeks to create a digital financial system that is fast, efficient, affordable, global, and easy to use. Since the 90s and early XNUMXst century, FinTech has been presented as the great evolution of finance, with the potential to reach more people and improve the financial experience.

However, the arrival of Bitcoin, Ethereum, and the early development of decentralized finance, or DeFi, changed the game. DeFi offers a more secure, universal, and borderless system based on blockchain technology. This opens up new possibilities beyond what traditional FinTechs offer.

Let's look at their main differences:

1. FinTechs are centralized entities that operate on software that is controlled and can be censored by their administrators. In contrast, DeFi operates on a decentralized blockchain, where the code is public and transparent.
2. Contracts in a FinTech are subject to the laws and regulations of each country, while in DeFi, contracts are smart contracts on the blockchain, equal for all and publicly auditable.
3. In FinTech, approvals or decisions go through a bureaucratic chain, which can delay responses. In DeFi, interaction is direct between the user and the protocol, with automatic approvals if requirements are met, eliminating intermediaries and waiting times.
4. FinTechs rely on the traditional banking system to manage funds, which means you must be banked and your money can be censored or limited. In DeFi, you only need a cryptocurrency wallet to receive and send funds freely, without the need for bank accounts.

In short, a FinTech is a digitized traditional financial institution, while a DeFi is a decentralized and autonomous blockchain-based platform. Well-known examples of FinTechs include Revolut and PayPal, which have digitized financial services while still maintaining centralized control.

Potential DeFi use cases

Decentralized finance, or DeFi, has emerged as a bridge connecting the wealth of cryptocurrency holders with a vast ecosystem of financial services. These services allow digital assets to be used to generate more wealth, opening up new opportunities for users around the world.

Below, we explore some of the most relevant DeFi use cases today:

Decentralized lending systems

One of the most established uses of DeFi is decentralized lending platforms. The way it works is simple: if you need a loan, you can offer your cryptocurrency as collateral. Unlike traditional or FinTech processes, which require paperwork and long wait times, DeFi platforms allow you to interact with a decentralized application (DApp) and deposit the required guarantee, you have access to the requested money in a matter of minutes. In addition, the conditions are usually more competitive in terms of interest rates and terms, thanks to the automation and transparency offered by the smart contracts.

Decentralized Markets

Another pillar of the DeFi ecosystem is decentralized markets. Decentralized exchanges (DEX), investment pools, financial derivatives, staking systems, and prediction markets are just a few examples. These platforms allow users to buy, sell, and exchange digital assets without relying on centralized intermediaries, increasing transaction security and privacy.

Payment systems

DeFi is also revolutionizing payment systems. The intrinsic characteristics of DeFi platforms, such as decentralization and autonomy, make them reliable bridges for processing payments between different blockchains. This facilitates fast, secure, and low-cost cross-border transactions, without the need for third parties to manage or validate transactions.

Banking and insurance services

Finally, DeFi is expanding its reach into banking and insurance-like services, without being traditional institutions. Some protocols allow users to make interest-bearing investments and, after a period, earn profits. There are also projects that issue stablecoins (stablecoins), offer digital identification systems and develop financial insurance based on smart contracts. These innovations reduce dependence on centralized entities and democratize access to complex financial services.

In short, DeFi's potential to offer a wide range of services is as vast as the creativity and dedication of those developing these solutions. This ecosystem continues to expand and promises to profoundly transform the way we interact with money and finance.

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's good to be aware that while DeFi offers great possibilities, you need to know what you're participating in and investing in. This means learning and understanding what the platform does, how it does it, and what tools are available to you. All of this is done to avoid unpleasant situations like losing 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 (now Sky.Money) to prevent investors from suffering serious losses due to any issues with the protocol's collateralization. You can imagine that if features like these exist in MakerDAO, other projects will also have similar, if not more, capabilities. 

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. 

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:

1. BISQ, a P2P exchange protocol built especially for Bitcoin and completely decentralized.
2. 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.
3. 0x, a protocol for building decentralized P2P exchanges that works on top of Ethereum. 
4. 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.
5. Kyber, a swap protocol for integrating exchange functionalities in applications with cross-chain operations.
6. MakerDAO and DAI (now Sky.money), a DAO and a stablecoin designed to facilitate the creation of financial applications built on Ethereum.
7. Augur, a protocol for creating prediction markets.
8. Corners, a DEX of stablecoins.
9. Aptos, a high-speed blockchain with advanced security and scalability features. Its architecture allows for processing up to 120,000 transactions per second, attracting DeFi developers to build fast, efficient applications with low fees.
10. Synthetix, a platform for creating and trading synthetic assets that represent real-world assets such as currencies, stocks, or commodities, all managed in a decentralized manner through smart contracts.
11. Year Finance, a protocol that automates the search for the best yield farming opportunities. Through intelligent, community-managed strategies, it optimizes the performance of investments in different liquidity pools.
12. Balancer, an automatic market making (AMM) protocol that allows users to create custom liquidity pools with multiple tokens and variable weights, facilitating advanced diversification strategies.
13. Aave, a lending and borrowing protocol that allows users to lend and borrow in a decentralized manner with innovative features like flash loans and variable interest rates.

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.