DeFi(decentralized finance) is a financial smart contract built on ethereum, set up to revolutionize the current centralized financial system in order to make the world’s financial services boundless and accessible to all. With Ethereum being the infrastructure for all DeFi project, DeFi aims to establish solidity in the digital assets space, to revolutionize our current financial system by utilizing smart contract to enable us to have trustworthy and decentralized financial services.
Clarifying the above statement, DeFi on ethereum aims to overturn our current set of traditional financial services and to replace it with decentralization and a new set of rules governing it through the use of smart contracts, DApps, DAI, and other layer 2 ethereum Blockchain services. Decentralized finance obeys the rules of smart contract and therefore the code is the law governing these services. DeFi is a combination of Blockchain on ethereum, smart contract and cryptography and in these cases, decentralization may vary and so by design it can exhibit some centralized features besides what will be made public for consumption. The early stage of DeFi were DEXes ie, decentralized exchanges, where smart contract is used to enforce trading rules, whereby one can exchange funds without an exchange operator, trades get executed, orders are directed peer to peer, neither signing up nor KYC is required and mostly no withdrawal fee needed. That was the beginning of DeFi revolution.
For a traditional finance business, government issues license for people who want to get into financial services to be able to run their business and there are regulatory rules, governing these financial services. DeFi on ethereum exhibit similar technological regulatory rules called the smart contract, developers program these financial services on the ethereum Blockchain and in a way, tokenize these financial services to have a native digital currency meant to be used for transaction for that particular project(Defi). In a real world, companies come about with shares and likewise in the digital finance world, you can tokenize any project to have its own native currency. Since the smart contracts are mostly built open-source, and information regarding services and how it operates are mostly public, users can verify to see the details of a particular DeFi project and choose to look into it to know if it best suits a service they are interested to invest in. And for that, most decentralized finance projects are similar to our traditional financial services but in these cases, in a decentralized flex. However, in this case of decentralized twist, smart contract connects and enforces all parties involve; for instance, in a case of loaning, it connects lenders to borrowers, smart contracts enforce terms on all services and for that the interest on an investment is distributed by the contract rules automatically.
Now one will ask, since volatility is a very big factor in the crypto space, wouldn’t decentralizing finance on ethereum suffer the risk of volatility? Now stablecoins come in this situation but there is a slight different between the stable coin you probably know and what is used in decentralized finance. For a usual stable coin like PAX or USDT, each token is backed by a single 1USD and for that they are backed by fiat to collateralize for sudden volatility. In the case of DeFi, all projects are pegged to ethereum based stablecoin, backed by fiat and at the same time ETH. In this case, we have a certain amount of ETH pegged to this stable coin as collateral for volatility. For example DAI, it is backed by the USD, and then in every 1DAI there is about $1.50 worth of ETH locked in as ethereum base stablecoin with a certain of amount of ether($1.50) locked in intrinsically. This is to offset for volatility in case digital asset prices drop. The meaning of all this ends with the fact that, DeFi projects must be pegged with a stable coin to be able to collateralized for digital assets volatility and also to protect investors. Example of one most popular Defi project is COMPOUND, offering lending services for people to invest so that they can earn interest over a period of time with terms and conditions applied. Some projects also include YFI, uniswap, Maker etc.
As at the time of writing, the total market capitalization of the DeFi ecosystem sits around $9.42 billion with uniswap on top of the ecosystem with about 20.27% dominance.
Digital finance is growing, although there are still limitation to the industry, the future still looks exciting for Defi because, as more and more people understand the current monetary system and weigh what is on the table(centralized systems) against decentralized systems, people will choose decentralization for the freedom it exhibit. Defi aims to build a fully automated, trustworthy and boundless financial system accessible to anyone without barriers of either your level of education, race or religion
The future seeming to be exciting doesn’t exclude the fact that potential risks must be anticipated in the decentralized finance ecosystem. First of all, the tech is new and will takes time to familiarize with the crypto space and build a solid integrity, thus, reasons for people to be able to trust projects, to see what is in reality will not be around few years to come. By design, smart contract can be built to have centralized features, the ecosystem must be around for a while for people to see how reliable and transparent Defi projects will be in order to make investment decisions. Secondly, there is an issue of smart contract bugs and change in protocols in case where project owners fail to do their due diligence.
With all the risk factors highlighted above, I still believe Defi is the future of money and for that reason let us all explore, do our own due diligence and see what this ecosystem turns out to be.
I Am CryptoRas.