DeFi; powerful financial products right at your fingertips

We know that the DeFi market has hit the $20 billion total value locked (TVL), according to DeFi Pulse, and this is only expected to increase throughout the coming years. But what is DeFi, and why is it becoming so popular in the crypto space?

DeFi (Decentralized Finance) is based on blockchain technology. It enables a peer-to-peer financial network where financial services such as trading, lending, investment, wealth management, payment, and insurance are decentralized through trustless and transparent protocols that run without intermediaries.

To understand the real dimensions of DeFi and why it matters, we must first look at its origins and how it differentiates from traditional financial services. The term DeFi first appeared in a Telegram chat in August 2018 of ETH developers and entrepreneurs when discussing what to call the movement of open financial applications being built on Ethereum, to open up traditional financial services to everyone by providing a permissionless financial service ecosystem built on blockchain infrastructure.

DeFi Landscape Source: The Block

The origins of DeFi

While DeFi draws on the same blockchain technology that gave birth to Bitcoin and Ethereum, it did not begin simultaneously. The crucial moment for financial applications allowing users to do more with their money than transferring from one person to another came about with MakerDAO in 2017.

MakerDAO introduced the Dai stable coin and allowed users to issue a cryptocurrency that´s pegged at 1-to-1 to the value of the U.S. dollar through the use of digital assets as collateral. DeFi is not merely a short for decentralized finance. In fact, its wording conveys a much deeper message as it comes out as DEFY (pointed out by Blake Henderson of 0x, who participated in the Telegram chat of August 2018). This revolutionary movement offers a strong value proposition whereby individuals and institutions use broader access to financial applications without the need for a trusted intermediary, such as traditional custodial banks, thus defying the current status quo. 

Source: Coinmarketcap.com

The financial system is the backbone of the world´s economies. Nonetheless, traditional financial systems have major issues and are subject to abuse and incapabilities linked to credit risk, lack of transparency, and unequal access. For example, The World Bank estimates that over 1.7 billion people worldwide do not have access to bank accounts or financial institutions of any type

Understanding DeFi

Most DeFi projects run on the Ethereum network. Ethereum differentiates itself from Bitcoin because it can be used for multiple purposes and build different decentralized solutions that reach beyond ordinary transactions due to their platform of smart contracts. DeFi applications have taken different shapes, including innovative cryptocurrency trading algorithms, derivatives trading, margin trading, money transfers, and most importantly, lending markets.

Core attributes

Non-custodial: means that people using it have control over their money and the value to be transferred from one person to another without financial institutions’ need. 

Open: meaning that these networks are global and borderless (everyone can access it like the internet).

Transparent: the code of these financial applications is available and open for anyone to see, meaning anyone can track exactly where their money or valuables are. 

Composable: It is open-source, and so other developers can build upon it, enhancing innovation and adding value with new applications being built. 

Decentralized: public blockchains (Ethereum) are powered by thousands of nodes-computers running the blockchain´s software worldwide, making it very hard to censor, tamper with or eliminate them. 

The Origins of DeFi

While DeFi draws on the same blockchain technology that gave birth to Bitcoin and Ethereum, it did not begin simultaneously. The crucial moment for financial applications allowing users to do more with their money than transferring from one person to another came about with MakerDAO in 2017.

MakerDAO introduced the Dai stable coin and allowed users to issue a cryptocurrency that´s pegged at 1-to-1 to the value of the U.S. dollar through the use of digital assets as collateral. DeFi is not merely a short for decentralized finance. In fact, its wording conveys a much deeper message as it comes out as DEFY (pointed out by Blake Henderson of 0x, who participated in the Telegram chat of August 2018). This revolutionary movement offers a strong value proposition whereby individuals and institutions use broader access to financial applications without the need for a trusted intermediary, such as traditional custodial banks, thus defying the current status quo. 
The financial system is the backbone of the world´s economies. Nonetheless, traditional financial systems have major issues and are subject to abuse and incapabilities linked to credit risk, lack of transparency, and unequal access. For example, The World Bank estimates that over 1.7 billion people worldwide do not have access to bank accounts or financial institutions of any type.

DeFi, on the contrary, offers a revolutionary alternative that is inclusive, puts people in charge of their money/assets, and is centered around trust and transparency with mostly open-source code.

ARYZE and DeFi

The traditional financial system fails to keep up with the pace of the digital age. For example, cross-border transactions take too long (an average of 3 days) and cost approximately 6.8 % in fees. This issue in high costs for cross-border transactions has been identified by ARYZE, whose aim is to reduce the costs of international money transfers to near-zero by building a full-reserve bank using regulated cloud-native banking software, interlinked with the world of blockchains and smart-contracts, thus transforming dumb money into smart money by enabling interoperability to the blockchain and making bank IOUS fully programmable. 

Next-generation DeFi or distributed finance solutions require assets that are not extremely volatile, and that is where interoperability comes into play. Whenever users use Digital Cash on an Open Source system or transfer deposits directly from MAMA to MAMA, ARYZE collateralizes with assets backed by government guarantees. We’re insuring working towards drastically reducing credit risk by placing user funds into central-banks deposits or through the purchase of short-term government bills and bonds. When money becomes fully digital, it can enable endless opportunities for creation, customization, and adaptation. Digital Cash will become the closest thing to a Central Bank Digital Currency without being directly issued and controlled by a government.

What are the risks of DeFi?

Overall, the issues with DeFi can be divided into high risks in vulnerability and user-experience issues. According to an article published by CoinTelegraph, one of the major problems is smart contract vulnerability and exploited errors, meaning that incorrect codes can provide an unintended gateway for loss of funds.

DeFi is a highly volatile market that creates over-collateralization. Lenders want significantly higher collateral to be put up for their loans, which ultimately undermines the idea of borrowing in the first place. Lastly, risk-adjusted pricing is non-existent, and at this stage, the liquidity cannot compete with the centralized alternatives.

Conclusion

Despite the current risks associated with DeFi, these problems will be resolved as the technology evolves. Whether its universal adoption will become a reality in the future or not is yet to be seen. But one thing is certain, the days of simply going to the bank are soon to end, and powerful financial products are right at our fingertips and fit into our pockets.

To learn more about ARYZE, crypto, blockchain, and tokenization, check out our blog or visit our website. If you liked this article please comment and share it with your network.

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