DeFi: The Future of Finance Lies in Decentralization

Decentralized finance (DeFi) has reached its peak since 2020. This market promises to bring cryptocurrencies closer to investors , especially the so-called “ unbanked” . However, the concept of DeFi is not something new, nor is it a fad . The technology is already over 10 years old and continues to evolve every year.

However, like any innovative market, DeFi is still approached with many questions. What is DeFi ? What do they do ? What solutions do they want to bring to which problems? And, most importantly, what are the advantages and risks that this new market offers? 

“ DeFi distances itself from Centralized Finance (CeFi) by ensuring greater security and the ability to innovate without any barriers. They operate on global, immutable, public, decentralized and open-source networks that are blockchains, bringing all these qualities to many of the products and services developed on them, creating an infinite range of previously unimaginable possibilities ,” explained the DeFi Portal.

In short, DeFi seeks to emulate traditional financial market mechanisms . However, the goal is to make finance more accessible and less dependent on large institutions . And to clarify how they will do this, and what the main DeFi projects are , we are starting this new series on Todaysgist : What is DeFi ? Come with us to learn about yet another cryptocurrency innovation.

DeFi and its origins

Like most things related to cryptocurrencies, DeFi started with the Bitcoin protocol . Satoshi Nakamoto’s creation emerged as a payment method that did not depend on banks or governments to be used. Each user could have their own bank and wallet. That’s why Bitcoin was the first successful DeFi application .

However, Bitcoin’s limitations meant that its use was limited to this. Other applications that are now associated with DeFi could not be run on the Bitcoin blockchain. It had become a huge success in being a strong, unconfiscatable currency that was free from political influence. But more was needed.

Ethereum and DeFi: The Perfect Marriage

It was only with the emergence of Ethereum that more complex applications could be executed on the blockchain. With this, the path was clear for the market to develop . And so another example of DeFi emerged: Initial Coin Offerings (ICOs) .

ICOs allowed companies to raise money without relying on bank loans or stock market listings. On the other hand, investors could buy the tokens issued by them, becoming partners in the companies and profiting from the appreciation of the tokens. In this way, ICOs decentralized the capital market.

The ICO market had its big moment in 2018. That year, several projects used this investment method to raise funds . However, several of them turned out to be scams , which contributed to tarnishing the image of this market. Even so, many ICOs continue to follow their schedules .

Decentralization of financial services

The second phase of DeFi began in 2020. As the ICO market cooled down, other projects began to emerge on the market. Their goal was to revolutionize not just a specific sector , but the entire economy . DeFi was now ready to operate in the following markets:

• Issuance of debt with collateral;
• Loans;
• Receive interest on invested cryptocurrencies;
• Buying and selling protection with options;
• Futures markets; 
• Make and operate synthetic assets (such as gold and stocks) on blockchain;
• Lotteries;
• And others.

It is possible to note that all these services exist in the traditional market . DeFi, therefore, did not necessarily create new financial products. What they did was bring these markets to blockchain technology . And this transaction came with several improvements, especially in ease of access .

Consider opening a bank account . This process is often very complicated and, in some cases, expensive . Not everyone can open a bank account and have access to investments . In poor countries with high inflation, such a limitation can mean the difference between life and death .

DeFi, on the other hand, cuts out these intermediaries. Banks, brokerages, financial institutions, and stock exchanges are not needed . Anyone with internet access can connect to a computer and access DeFi services. The costs are much lower , the speed is faster, and there are no geographical or financial restrictions .

As a result, several projects have started receiving capital from investors who believe in the potential of DeFi. Some of these projects have received billions . This metric is measured by Total Value Locked (TVL), which shows which projects receive the most investment. The DefiLlama website  has a complete list , in order of value locked.

DeFi Examples

The last two years have seen a veritable explosion of DeFi projects. New protocols are being created every day, each with its own functionality and purpose . Furthermore, the origins of these protocols have become more diverse . Ethereum, for example, has started to have new competitors, with DeFi projects emerging on other networks.

An example of this is decentralized exchanges (DEX) . These platforms are brokers where crypto assets can be exchanged . However, DEXs are, as the name suggests, decentralized. They do not hold custody of cryptocurrencies, nor do they require users to make any deposits or send any documentation . Here are the advantages of DEXs compared to decentralized exchanges:

• Non-custodial : there is no need to deposit money into DEXs: just connect a wallet and carry out transactions. Cryptocurrencies transacted on a DEX never leave the possession of their owners. This reduces the risk of theft and attacks;
• Automation : DEXs have no intermediaries. Trading on them is instantaneous, as long as there is sufficient liquidity;
• Lower costs : Traditional exchanges often charge high fees for their operations. On the other hand, most DEXs have minimal trading fees, allowing you to trade at much lower costs;
• Ease of access : centralized exchanges usually ask for documentation and have a series of bureaucratic processes. Most DEXs, on the other hand, do not usually ask for much data, which protects users’ privacy;
• Usability : DEXs are becoming easier to use. The process of buying and selling cryptocurrencies can, in many cases, be done with just a few clicks;

This makes the exchange between DeFi tokens faster and safer . The risk of losing cryptocurrencies due to a hacker attack , for example, is much lower, practically zero. And these platforms also provide access to yields via Proof Of Stake ( PoS ) or token loans , generating passive income . Here are some of the most famous DEXs in the DeFi ecosystem:

• Uniswap : created on the Ethereum blockchain, therefore it allows the trading of both Ether (ETH) and ERC-20 tokens;
• PancakeSwap : practically a copy of Uniswap, it works on the Binance Smart Chain. Therefore, it allows the trading of tokens created on this network, which already presents competition to Ethereum;
• 1inch : 1inch is a DEX aggregator that provides data for users to choose the best platform. It is also a DEX and allows the exchange of cryptocurrencies. It is possible to identify platforms on both Ethereum and Binance Smart Chain (BSC);
• OpenSea : auction platform for digital art tokens, also known as NFTs. Here, artists and collectors can trade works quickly, without intermediaries and from anywhere in the world.

The last two years have seen a veritable explosion of DeFi projects. New protocols are being created every day, each with its own functionality and purpose . Furthermore, the origins of these protocols have become more diverse . Ethereum, for example, has started to have new competitors, with DeFi projects emerging on other networks.

An example of this is decentralized exchanges (DEX) . These platforms are brokers where crypto assets can be exchanged . However, DEXs are, as the name suggests, decentralized. They do not hold custody of cryptocurrencies, nor do they require users to make any deposits or send any documentation . Here are the advantages of DEXs compared to decentralized exchanges:

• Non-custodial : there is no need to deposit money into DEXs: just connect a wallet and carry out transactions. Cryptocurrencies transacted on a DEX never leave the possession of their owners. This reduces the risk of theft and attacks;
• Automation : DEXs have no intermediaries. Trading on them is instantaneous, as long as there is sufficient liquidity;
• Lower costs : Traditional exchanges often charge high fees for their operations. On the other hand, most DEXs have minimal trading fees, allowing you to trade at much lower costs;
• Ease of access : centralized exchanges usually ask for documentation and have a series of bureaucratic processes. Most DEXs, on the other hand, do not usually ask for much data, which protects users’ privacy;
• Usability : DEXs are becoming easier to use. The process of buying and selling cryptocurrencies can, in many cases, be done with just a few clicks;

This makes the exchange between DeFi tokens faster and safer . The risk of losing cryptocurrencies due to a hacker attack , for example, is much lower, practically zero. And these platforms also provide access to yields via Proof Of Stake ( PoS ) or token loans , generating passive income . Here are some of the most famous DEXs in the DeFi ecosystem:

• Uniswap : created on the Ethereum blockchain, therefore it allows the trading of both Ether (ETH) and ERC-20 tokens;
• PancakeSwap : practically a copy of Uniswap, it works on the Binance Smart Chain. Therefore, it allows the trading of tokens created on this network, which already presents competition to Ethereum;
• 1inch : 1inch is a DEX aggregator that provides data for users to choose the best platform. It is also a DEX and allows the exchange of cryptocurrencies. It is possible to identify platforms on both Ethereum and Binance Smart Chain (BSC);
• OpenSea : auction platform for digital art tokens, also known as NFTs. Here, artists and collectors can trade works quickly, without intermediaries and from anywhere in the world.

What (or who) is DeFi for?

As we’ve seen, DeFi serves as a way to make financial services more accessible . Although they are new technologies , they have enormous potential . And as protocols become easier to use, the market for them becomes larger . After all, banking is one of the most exclusionary areas in the world.

According to the Global Findex survey , 31.5% of people in the world do not have a bank account . This corresponds to 2.3 billion people without access to banking services. This is because, unlike in Brazil and most countries, opening a bank account in many countries is an expensive process full of barriers . Because of this, many people end up not being able to obtain loans or make investments , among other services.

On the other hand, most countries in the world have at least one cell phone for every inhabitant. In other words, access to devices that can support DeFi technologies is much greater than access to traditional banking services . And it is through this greater access that DeFi can grow and gain more space .

Today, there are several DeFi platforms that allow you to deposit money without needing a bank account. This means that small savers have immediate access to financial services. Many of these services, in fact, pay higher interest rates than traditional market investments, such as fixed income and government bonds .

DeFi Risks

Although innovative , DeFi also presents risks for investors. These risks can involve both the protocol and individual risks . Many DeFi projects are still new and therefore need to prove their security . There are many cases of DeFi protocols that have been attacked and caused their investors to suffer huge losses .

Another issue that can affect DeFi is errors in project contracts . These flaws can result in problems with the execution of the protocol, generating heavy losses . That is why it is important to carefully observe the team behind each protocol and check whether the codes and contracts are well audited and checked .

But investor euphoria can also be a problem. Investing in a DeFi project without understanding the risks or how wallets and other aspects work can be a mistake . The same goes for investing in tokens that have already “ bombed ” and therefore offer a higher risk of devaluation .

Finally, there are regulatory risks , something that affects virtually all cryptocurrencies. Governments are still struggling to fit cryptocurrencies into their traditional boxes. And many of them, due to inability or lack of knowledge , may end up making certain protocols illegal . 

DeFi promises to be a major revolution in the financial system . In fact, it is already bringing about several changes and gaining prominence . However, the sector is still young and has a long way to go. Just like our series of articles, DeFi is only in the early stages of this journey. So stay with us and check out this evolution .