What is DeFi? Decentralized finance Guide 101

Is DeFi (decentralized finance) here to stay?

The concept of DeFi erupted with unusual force almost out of nowhere.

Not so long ago, no one knew what that meant. But even a few years after its implementation, it is a very little-known concept.

If you ask people on the street, most of them have no idea, especially old people.

And yet, we are faced with something that can change finances forever.

In this guide I will tell you how is the definition of DeFi or Decentralized Finance, and all the keys to understanding them. It is the basis of an entire financial system, no less, so the subject gives a lot to say.

What is DeFi?

DeFi is the diminutive in English of “decentralized finance”, which we translate into Spanish as decentralized finance.

The key here is in the term "decentralized".

This means that it is a financial system that does not depend on centralized organizations, but rather, thanks to technology, is designed so that all its transactions are decentralized, i.e. without financial intermediaries.

Instead of intermediaries, they base transaction trust on contracts smart, which verify their ownership and veracity.

How to understand this with an example or in a practical way?

Well, today's financial world is quite centralized, especially from the point of view of monetary creation, a power that belongs to the state and its collaborating entities, central banks and commercial banks.

When we want a loan, the most logical thing is to go to the bank, and there this entity will grant us capital that another person or entity has put in place. We therefore act with an intermediary.

In DeFi, when you want a loan, you do it directly with the lenders. In other words, there is no bank.

The only thing required is an internet connection and the use of technology platforms where users can trade their digital properties directly with the strictest online security protocols.

He's similar to early systems Bittorrent or eMule, for those who remember. These open-source platforms were used by thousands or millions of users who exchanged files person-to-person or node-to-node for free.

In DeFi, it's similar.

Imagine a kind of Torrent with hundreds of thousands of users where some make cryptocurrencies available to others who are willing to pay interest. There, the transactions take place directly and you just need to make sure that they are secure.

So the consequence of reading this far is:

If decentralized finance eliminates financial intermediaries, they directly threaten global financial powers, especially banks, but also all financial entities, including brokers.

This assures us that there is going to be a battle, because banks won't want to lose their business like this.

DeFi Features

Transparency

All transactions are verified by other users, which means there is complete transparency in the operation.

It also means that at the same time all these transactions are accessible to everyone, so that the possibility of advanced data studies is activated by all users, without there being any benefit for the other.

On the other hand, this is done while maintaining confidentiality as each user operates under an encrypted address with keys or passwords.

No permission required

This in English is known as permissionless, and it means that it is not necessary to receive permission from an intermediary to be able to interact in the system.

The only thing needed is to have access to the internet and tokens or cryptocurrencies to be able to interact.

A personal opinion: this is generally not commented on, but the problem would come from the side of who controls the internet? Permissions may not be required in DeFi, but nothing is said about accessing it. This is a point for further discussion, no doubt.

Immutability

For the system to work, complete security must be ensured. As much as if we were exchanging products from hand to hand.

In the case of blockchain, this is achieved with advanced data transmission protocols that ensure that transactions are unique and immutable.

Programmability

The system can be completely programmed, which facilitates all the automations that can be carried out, something crucial in the Ethereum environment, a blockchain specially optimized for these tasks and which is currently key in the DeFi environment.

Not custodial

When we transact in DeFi, custody is performed by us in our own digital wallet, e.g. Metamask.

This is totally different from traditional finance, where we need other entities such as banks, insurance companies, lending entities, dealers, etc.

Again, DeFi brings us closer to ancient finance, where the coins were in our pockets, that is, in our custody.

interoperability

Protocols and applications have the ability to be integrated regardless of the blockchain technology they use.

It's a system that gives maximum flexibility to developers, which also means that potential is maximized, because there are no limits.

History and origin of DeFi

The history of DeFi has no clear start date.

There is no official start, but the concept gradually gained popularity as apps were created that made it clear that the future of blockchain was to create a decentralized digital system.

We can say that it all started with Bitcoin in 2009, that although we cannot clearly say that it is DeFi, it marked the beginning of the world of decentralized applications.

Then came Ethereum, the key protocol to advance the possibilities of blockchain and the DeFi world.

Let's say Bitcoin was the currency or currency and Ethereum the language in which the rest of digital financial services such as lending, derivatives, transactions, etc. could be created.

After Ethereum, it was only a matter of time before the first finance-like decentralized applications begin to emerge.

One of the first was Maker, in 2014, although the project only launched in 2017.

This year 2017 was important because it saw the birth of other flagship projects in the history of DeFi. Projects like EtherDelta.

ETherDelta was the first decentralized-like exchange, but it didn't last long as it was hacked soon after, joined by a regulatory hunt from the SEC, ending the project.

ICOs also came, many of which were DeFi projects, like AAVE, Synthetix, Kyber Network ou Bancor.

After this start came the key years of 2020 and 2021, amidst the tumult created by the pandemic, the crypto and DeFi markets saw incredible volatility, which really revived the popularity of decentralized finance.

From there, I think I can already say that they have come to stay.

How does decentralized finance work?

The main function is to allow financial exchanges between individuals or companies without intermediaries.

How is this done?

Well, via DAPPs, which are decentralized applications that work through blockchains or blockchain.

Transactions are mediated by smart contracts based on the Ethereum or similar blockchain. These smart contracts replace traditional intermediaries, which are no longer necessary to give validity and legality to transactions.

We're going to look at some things we can do with DeFi, to better see what it's all about, that the concepts around them are a bit strange to some.

What can we do with DeFi?

Think of all the things you can do today from a financial perspective, and you already have what you can do with decentralized finance.

Only the way of doing it will be different.

Among other things, we can do the following:

1 Send and send money anywhere in the world

Within the DeFi blockchain, currently dominated by Ethereum, it is possible to perform all kinds of transactions with any other address in the system, that is, we can make and receive payments with n' any participant in the world under the same conditions, regardless of where they are.

This feature clearly teaches us that DeFi is made to unify the world, which can only really be achieved digitally.

The only thing needed to be able to perform these transactions is a wallet or purse.

2 Borrow money

Here we have one of the classic and most important functions of the traditional financial world.

A function that has been lacking for a lifetime and for which banks have mainly been used, but also loans between friends or family.

With DeFi, it is no longer necessary to go to a bank but you can go anonymously to borrow on decentralized markets, which you can do “directly” with “peer to peer” (P2P) or via pools of liquidity that can be found on various platforms.

This way we can go to one of these markets and get a loan.

But who is going to lend us without knowing us and without guarantee?

Here comes the hard part, because the truth is the first thing that comes to mind.

This is solved with the need to present a guarantee, that is, some kind of guarantee. Such that if we do not make the payment, the lender will liquidate it and take possession of the tokens, which can range from cryptos to certain NFTs.

This is currently the case, but I think to work well there should be a way to know the credit quality of potential borrowers. That of lending without knowing who you are dealing with complicates the process a little and therefore the need for a guarantee.

Not to mention the possible scam attempts, something that those who develop the subject want to eliminate with the creation of a unique digital identity, so that it is not easy for you to "run away with the money and disappear into the black hole of the world”. digital".

Among the benefits of borrowing on DeFi markets we have:

• Access to global liquidity
• Confidentiality in the transaction (which comes with its "but" as I just said)
• Instant loans (flash loans), used in crypto trading and exchange operations
• Tax efficiency (raising funds without the need to temporarily sell assets)

3 Borrow money

Wow, decentralized finance also gives us the opportunity to be loan sharks and make money by lending what we have saved.

The loan shark story is a joke. Here, no one is forced to take out a loan they don't want. If anything characterizes this market, it is its transparency.

With DeFi, instead of putting our money in the banks and looking for a deposit or a product with interest, we do it by lending money directly, because there are many projects looking for short, medium or long term.

Due to the dynamism and volatility of the DeFi market, attractive rates of return can be achieved, for the time being, of course.

4 Token and Crypto Exchange

One of the most sought-after activities when you go to DeFi is trading assets, which we can do in more traditional cryptocurrency markets in centralized exchanges.

In decentralized finance, we can do this through DeX, i.e. decentralized exchanges.

5 Use stablecoins

Who wants to hold Etherem as collateral for a loan or as an asset on which a contract depends?

With volatility impossible or at least not recommended.

For this, decentralized finance has created the concept of Stablecoins, a discovery that solved this volatility problem.

These “stable currencies” are stable because their value is linked to that of the main fiat currencies like the dollar or the euro.

In this way, they serve as a savings unit and we can save money with them or carry out any type of operation with the guarantee that the volatility will be within controllable ranges.

Some of these stablecoins are USDT, TUSD or USDC.

6 Derivatives trading

The DeFi market has no limits, nor are there any regulations that can reach it, at the moment, so we can do the most advanced kind of trading we can imagine.

This is why many derivatives and margin trading sites have been created, among other trading functions.

7 crowdfunding opportunities

If you have an interesting idea that can solve some problems in digital environments, you can try to obtain funding in the DeFi system itself.

Many projects are already seeing the light of day thanks to the funds obtained in this environment.

As it is a transparent system, all users can check how the money is collected and where it is spent.

8 Insurance business

For the moment, it is a market that is not extremely developed. We can say that it is starting, but the capacity is there.

There is no limit to the performance of insurance contracts between insurers or actuaries and users.

Even if you have a good knowledge of actuarial science and probabilities related to insurance, you could offer your services as an insurer to other users.

9 Market Forecast

DeFi has the perfect environment to create all sorts of betting and other markets on the possible outcomes of any type of event.

In other words, I'll tell you in other words: DeFi can end up creating its own decentralized betting markets without the dealer, like Betfair, charging its commission, and so bettors do it directly against each other the others without having to pay these differences. or additional commissions.

10 Aggregators

Imagine that you have a fairly large activity in the DeFi space, with various products under contract.

It can be an inconvenience to have to go to each of the platforms to see how things are going.

Well, this is solved by the powerful architecture of DeFi, and aggregators have already been created to unify all products in one place, such that we have a kind of unified wallet.

11 Index investing

You can't just invest in index funds or ETFs, like on the stock market. DeFi also brings us its own sophisticated index funds that allow us to invest in the best of the decentralized finance market without having to worry.

It would be something like investing in the Dow 20 or 30 of DeFi, so that the fund, of which there are already several, includes the most successful tokens and projects. and removes the worst, thus behaving like a good investment fund. .

12 lotteries and risk-free prizes

Yes, what you read.

DeFi has also given the possibility of creating lottery and other games in which no money is lost.

More comment is it possible?

Well, by having players' money, which is placed in a common fund, earn interest. This way, at the end of the game, we will have the initial funds plus the interest gain.

What the game does is distribute the money among all the players and some will take more money than they put in.

An example:

1 players invested 000 ETH each.

This gives us 100 ETH.

At the end of the game, there are 105 ETH.

999 players get 0,1 ETH and 1 gets 5,1.

This is a very simplified example but it is to give you an idea.

Is decentralized finance safe?

This is a crucial question for the success or otherwise of a financial system.

If it's not safe, forget how good or effective it can be.

Although we also cannot expect a system to be 100% secure. Even the traditional financial system was not, but at least it respected a minimum of security in order to guarantee the functioning and the confidence in the system.

Everywhere they can steal from us.

You don't get rid of stealing your wallet on the street or trying to scam you in a business.

Well, in decentralized finance, it's the same thing.

What happens is that the traditional financial system and the precedents have always reached a level of security high enough that its trust in society guarantees its operation.

this seems to be the biggest challenge that DeFi has in front of it.

At the moment this is a completely new system and therefore it is not possible for us to have the same security that we can have when entering into agreements with a bank. It is very difficult to steal bank money from us, but in a DAPP you don't know.

What I mean is that DeFi has the potential to be very secure , but since it's a very new market, it still has many security holes and issues, things that will work themselves out over time, especially when it starts to go mainstream. use.

In this sense, they are similar to cryptocurrencies. When these were born in 2009, and in the following years, the market was crazy, and scams and hacks were quite common. We were in a Wild West. Today the market is much more stable and thefts are not that common, and also as institutional participation increases it becomes more robust.

I think the same is going to happen with DeFi.

Over the years, and if they gain popularity, better security protocols will appear, and it will be more and more difficult to do tricks and scams.

But beware, scams will never go away.

They will exist as long as there are transactions between human beings.

What problems can DeFi have today?

Irreversibility

It is a problem and a blessing at the same time. The irreversible nature of the operation means that there is no way to undo it once it has been performed. If the money went to another blockchain address by mistake, we can say goodbye to it. It is very difficult to recover it.

The novelty of the market

Brings out many products that lack quality and will end up in resounding bankruptcies or failures, with all that that entails. Since there are quite a few bankruptcies and many people are losing money, it will look like the market is a scam, but in reality this is what usually happens in innovative markets, where there are has many projects that failed in the early stages.

There are scams directly

In addition to the previous case of failed projects, there are also many people dedicated to creating projects that are scams. They do this because they know the market is hot and if they are able to copy and create a project that looks good, they can attract many investors. So we already know what's going on: they run away with the money, and goodbye.

There is no possibility to know the customers

This causes problems in financial markets such as loans. If we cannot verify the lender, it is difficult for us to lend money. As I mentioned in the section on loans, at the moment it is solved with guarantees, but it is not ideal for the future. This is where the concept of digital identity comes in, something that on the other hand has its dangerous side is that you lose your anonymity.

Decentralization is not the panacea we are told

Despite the fact that they sell us that it is a decentralized system, the truth is that when we use the platforms or the DAPPs, we depend in some way on their proper functioning, and it is impossible to guarantee that this is always the case, or that there are no people who have some control over them.

They are not that easy to use

For those who have used DeFi, sometimes the market seems a bit chaotic and it's not that easy to use, really. It's not very reliable at the moment, and many people are hesitant to put a lot of money.

There are hacks in some DAPPs

The fact that these are decentralized applications does not prevent hacks. Online theft masters are always devising new ways to steal people's money. Sometimes they do it through the platforms, and sometimes they do it directly, trying to access your computer and get the access keys to your wallet. You must be very careful, especially if you are moving a considerable amount of money.

Advantages and disadvantages of DeFi (compared to traditional finance)

✔️Remove all barriers to global trade

In the digital world, there are no barriers or borders.

The person who is in Indonesia has an address like the one who is in the Netherlands. The two can trade tokens as if they were neighbors by exchanging bread for eggs.

Traditional bank-like finance cannot achieve such a thing.

This makes decentralized finance a fundamental element of equality. They make the world equal, so to speak.

✔️Allows access to finance to many people outside the system

In many countries, many people do not have access to complex financial services because they do not even have a bank account.

DeFi breaks this barrier and just having a mobile allows these people to have a wallet and be able to transact such as loans with anyone else in the world.

✔️Possibility to earn interest in a declining financial world

It's no secret that in the West, the financial world is failing on all sides. Today, it is impossible to obtain products that bring savings.

This means that little by little more people are taking an interest in DeFi and starting to invest their savings in products such as Yield Farming, with which they can obtain good interest rates (not without risk, of course).

✔️They suppose or can suppose a big saving for the users

Not having intermediaries makes the cost of financial transactions much cheaper.

If DeFi is able to scale enough and create massive transaction systems, we can see a world in which middlemen take up a lot of the business. We would be facing a more egalitarian world, where the individual, or at least his digital counterpart, would have more power.

This is something the banks are not very happy with.

✔️Quick and permanent access

In ancient times, for people who lived far from the city, obtaining certain products meant losing a day or more of travel, with all the problems that entailed.

With DeFi, all distance and time issues are eliminated in one fell swoop.

A simple press of a click and we are ready to buy any token we like.

I even suppose that one day we will be able to order food in DAPPs.

❌Lack of liquidity

Despite all that has been said and the fact that more and more money is being moved, there are still serious liquidity problems in most projects.

This means that operating there is not as cheap as one might expect.

For example, in some of the DeXs, there is so little liquidity that the transaction costs are very high, and it is not worth using it at the moment.

Compared to this, traditional entities such as centralized exchanges or brokers offer a much more powerful trading experience.

❌There is no one to claim

If you make a mistake, whether it's security or sending money to the wrong site, there's nothing you can do.

Unlike the traditional monetary system, where we can make legal claims, DeFi operates in a much more “wild” environment, so you have to be very careful with what you do.

❌Uncertainty

Being such a dynamic market, we really don't know what's going to happen.

In this article, I've talked as if decentralized finance is going to be the financial future, but no one can say that for sure.

Things could go wrong and be something else.

This uncertainty affects all projects equally. In a way, we are in something similar to the early days of the Internet.

How many projects have not failed then?

❌Lack of insurance coverage

There are still no institutions that guarantee what happens inside the “Wild West” of DeFi, so whatever happens inside is your responsibility.

This is bad, but good at the same time, because it is a sign that we are in the “new frontier”, and it is in these frontiers where there is more likelihood of doing business.

Future of DeFi – Final Opinions

Well, if you read the whole article, you will have realized that we are in a new market which is still in full development.

Let's say that we are in the first years of the life of this system and therefore in its infancy.

It is too early to draw definitive conclusions.

There are many opportunities, especially for new entrepreneurs stuck in traditional sectors.

There are also many threats. It is something logical and normal in uncharted territories. But remember that if you are one of the first explorers and you discover interesting things, you will be one of those who will benefit the most if the adventure ends well in the end.

At the moment, there seems to be a good chance that DeFi will end up being adopted by more users in the future.

Financial intermediaries, however, may not be very happy with this development and we are likely to see attempts to hinder the adoption of these protocols.

From a personal point of view, I see that it is a perfect ecosystem to form a digital economy.

If in the near future we have a radical move towards virtual realities, DeFi could serve to lay the foundation for what the financial system should look like in said reality.

The problem with that is what I see taking shape in the real world.

In other words, as the possibility of limitless virtual reality increases, we see how the real world becomes more and more authoritarian.

The trend seems clear that we are moving towards a system where the state will control almost everything we do in physical reality. It seems that there will be little land on which to carry out real private transactions.

DeFi and virtual worlds would be like the escape to continue to exercise the freedom of choice of products, but it would no longer be the same thing.

From my point of view, the ideal would be this virtual world mixed with the possibility of having a real world with freedom too.

We'll see how events unfold and what's left of it all.