What is Decentralized Finance?
Key Takeaways :
- Decentralized Finance is a blanket term used to describe the emerging financial ecosystem being built on top of existing blockchain infrastructure;
- Decentralized Finance protocols are able to seamlessly integrate with one another to create unique financial products and services, this ability is commonly referred to as “composability”;
- DeFi levels the playing field through its accessibility, efficiency, and opportunities, however it currently suffers from drawbacks like poor user experience, unpredictable fees, and scammers.
“DeFi” is a simplified term for Decentralized Finance that refers to financial services offered via decentralized networks. By this very broad definition, there are numerous cryptocurrencies which would qualify as “DeFi” in that they’re (1) created, stored, & transferred across blockchain-based decentralized networks and (2) possess the characteristics of a store of value or medium of exchange.
However, decentralized finance is most often used to refer to the emerging blockchain-native financial ecosystem that is powered by smart contracts and distributed applications. Leveraging the unique benefits of blockchain technology, specifically security and accessibility, new products and services have been introduced that have the potential to solve key challenges that exist in our current global financial system.
Bitcoin: The Original DeFi
Bitcoin deserves to be highlighted in this article due to its nature as the world’s first DeFi product. In 2008 it emerged as an idea in a whitepaper called “Bitcoin: A Peer-to-Peer Electronic Cash System” by an author using the pen name Satoshi Nakamoto. Bitcoin’s key features were: coordinated decentralization, immutability, permission-less, and a fixed monetary policy that would never see Bitcoin supply exceed twenty-one million coins.
Many believe that, due to the timing of Bitcoin’s emergence, it was created in response to the financial collapse of 2008, which many attribute to banks being irresponsible with their customers’ money. Bitcoin would cut banks out of the equation and circumvent the Federal Reserve who continuously inflates the dollar and devalues peoples’ hard-earned savings. By capping the total supply, Bitcoin would be seen as a store of value due to its scarcity, with many drawing comparisons between Bitcoin and traditional stores of value such as Gold and Silver - assets that also have fixed supplies. While Gold and Silver have undoubtedly proven themselves as effective stores of value, Bitcoin brings the added benefits that come with being digitally native in a world that is rapidly moving online.
Ethereum: Introducing a Foundation for the Decentralized Future
Building on the principles and success achieved by Bitcoin, Ethereum was introduced in 2015 with the vision of increasing the utility of the underlying blockchain technology by creating a foundation for decentralized applications and smart contracts to be built upon. Similar to the value that Apple’s App Store offers developers creating new mobile applications, Ethereum rapidly became the top destination for developers building applications for an industry that was ripe for disruption: finance.
How DeFi Works
Decentralized finance consists of applications that are hosted on a blockchain and enable individuals to facilitate financial transactions via autonomous computer programs, which are known as “smart contracts.” These smart contracts are capable of executing a financial transaction without the intervention of a middleman or other intermediary, such as a banker, lawyer, or accountant.
In fact, DeFi is so easily accessible that individuals only need to have a cryptocurrency wallet to access DeFi protocols and execute financial transactions. The cryptocurrency wallet provides the secure gateway between an individual’s public blockchain address, which is where the digital assets are stored, and the DeFi protocol that facilitates lending, borrowing, staking, yield farming, and voting.
Similar to how mixing ingredients in a recipe produces a dish that’s tastier than the “sum of individual parts,” the utility of DeFi protocols is enhanced by seamless interoperability with other DeFi protocols to create new financial products and services. DeFi protocols ability to integrate with one another, referred to as “composability,” has provided retail investors with access to wealth-generating investment opportunities that have historically been reserved for accredited investors.
With the increasing number of options in DeFi, there has been a growing need for platforms to help make investing in DeFi both easy and centralized. WonderFi was created to simplify the process of learning and investing in DeFi, while providing a single access point for the growing list of financial opportunities made available by blockchain. Whether it’s generating significantly higher interest rates on a savings account or staking opportunities to earn higher returns, WonderFi delivers an experience that’s easy-to-use and convenient for any investor looking to benefit from DeFi.
What are the Advantages of DeFi?
Since the start of 2020, there have been three key advantages of decentralized finance that have ultimately led to its rapid adoption and evolution: accessibility, revenue generation, and efficiency:
Whether it’s access to a checking account or student loan, the current financial system has become a staple of our daily lives. While the emergence of DeFi can reshape our relationship with financial institutions, the most profound impact will be experienced by the 2 billion individuals globally who do not have access to basic financial services. Due to political or economic factors, these “unbanked” individuals are left to find alternative options to store wealth and exchange of value such as livestock, perishable food supply, or loosely-owned land titles.
However, there is a technology that can easily fuel the growth and access to decentralized finance to these 2 billion individuals: mobile phones. According to a Gallup World Poll in 2018, 83% of adults in the developing world have a mobile phone. With connected devices readily available and affordable, decentralized finance can provide a stable financial system - a gateway to the global economy - for billions of people around the world.
2. Investment Opportunities
One of the most prominent differentiators between decentralized finance and traditional banking services is the yield-generating opportunities made available to users. Compared to the .5% interest rate that you would get with a traditional high-yield savings account, it’s often eye-opening for many new DeFi users to find that they can receive interest rates starting at 4%+. They’re often even more excited to find that they can compound that interest by utilizing DeFi platforms that offer complementary staking and lending services.
Throughout the DeFi landscape, smart contracts and decentralized applications have created a transparent, auditable, and efficient system to facilitate a wide range of financial services. Despite the advances in technology that have made our lives more digital and connected, our global financial system has firmly remained in the analog era. From costly wire transfers to time limitations when the NYSE is open for trades, the automated and permissionless nature of DeFi delivers a tremendous opportunity to disrupt the current financial system.
What are the Challenges of DeFi?
While there are significant advantages to decentralized finance, it’s important to be mindful of risks and challenges that exist in the developing market:
1) Transaction Fees
While blockchains, such as Ethereum, have provided an opportunity for DeFi to flourish, it’s important to note that investors are subject to network fees - otherwise known as “gas fees.” These fees are attributed to the cost of executing and broadcasting a transaction to a blockchain. With increased activity and congestion on Ethereum, there have been instances where investors were presented gas fees in excess of $200-$300 per transaction.
2) Ease of Use
While DeFi provides unparalleled access to financial products and services, many new investors find the steps required to get started and participate daunting and complex. New investors are often required to learn new concepts while navigating a litany of sites, browser extensions, and technical requirements to reap the benefits of DeFi.
3) Bad Actors
Similar to other markets that attract significant amounts of capital, there are bad actors in cryptocurrency who attempt to deceive and defraud investors. It’s imperative to do sufficient research on your investments, secure your digital assets offline on hardware wallets, never interact with a platform you cannot prove is trustworthy, and avoid sharing sensitive information with others online.
Within a few years, decentralized finance has achieved more in disrupting the financial industry than the FinTech industry has been able to do in the last twenty years. From large financial institutions to retail investors, excitement continues to build around how decentralization can deliver more value for more people around the world. From citizens in developing countries to small business owners in the United States, decentralized finance is well-positioned to change a cornerstone of our daily lives for the better.