What is Decentralized Finance (DeFi)?

DeFi is a system of open, permissionless, and interlocking financial products built on Ethereum with a focus on borrowing, lending and banking services.

In the world of traditional finance, the money supply is controlled by a small group of central banks who work with a small group of corporate banks to effectively keep the world running. While that system has, by and large, kept the lights on for the world economy for the best part of a century, it does have its limits. One of which is access. At present, roughly 1.7 billion people are not part of this network, through a variety of reasons; be it a permanent address, credit history or reliable enough banking infrastructure. Blockchain, and in particular, decentralized finance, or DeFi, has been touted as a possible solution to lowering the barrier of entry for those who had previously struggled to gain access to things like bank accounts and borrowing. 

Is decentralized finance or DeFi the beginnings of a new financial system – a financial system that’s global, permissionless, and internet-native? Is this the dream of programmable money realized? Let’s find out.

What is DeFi?

As a concept, DeFi is a system of open, permissionless, and interlocking financial products.  In practice, DeFi is an overlapping network of dapps and smart contracts built on Ethereum with a focus on financial applications such as borrowing, derivatives, exchanges, trading, etc. 

Who invented DeFi?

There is no single inventor of DeFi, but DeFi applications are built on top of Ethereum, which was invented by Vitalik Buterin. The current largest and first major DeFi application is MakerDAO, which was founded by Rune Christensen.

What’s so special about it?

The excitement around DeFi centers on the concept of “money Legos”–the idea that anyone is able to create, modify, mix-and-match, link, or build on top of any existing DeFi product without permission. DeFi protocols are modular so they can stack on top of each other to build an increasingly denser system of interoperating parts.

The feature of open interdependence may also be DeFi’s biggest weakness because if a key component such as DAI becomes vulnerable or corrupted; the whole ecosystem built around DAI may come crashing down.

What else is different?

Besides being able to stack on top of each other in nearly limitless ways, DeFi products also open up financial access to millions of people around the world. A payment system in which anyone on earth can send money to anyone else on the planet was just the start of the crypto revolution. The people building DeFi applications seek to take accessibility one step further. By building products on a decentralized network like Ethereum, anyone with an internet connection is able to access lending services, complex financial products, stable stores of value, and investment and trading opportunities. Since DeFi products are simply code distributed across a decentralized network, they can also never be shut down or denied to those who want to use them. 

But like with any new technology, the boundaries to entry remain: access to reliable internet connection, electricity, and gatekeepers; those people are maintain infrastructure that allows peopel to convert fiat currencies to crypto.

How are DeFi applications produced? 

Anyone capable of writing smart contracts is able to create DeFi applications. InstaDApp was able to build a widely-used DeFi product by simply building a better user interface on top of existing DeFi products.  By making access to DeFi more user-friendly and simplified, they were able to cause a spike in other DeFi products and managed to raise $2.4 million in funding – all without asking for permission.

How do you use DeFi products?

Anyone can use DeFi products by going to an application’s website and connecting with a MetaMask wallet or something similar. Most DeFi dapps do not require users to give up any personal information or register, but ETH is required in order to pay for transactions on the Ethereum network.

What can you do with DeFi?

Users can take out a loan or earn interest on stablecoins using MakerDAO’s Oasis app and Compound. Tokens and crypto assets can be exchanged without registration or sign-ups on Uniswap and Kyber. You can even buy tokens that automatically place trades for you using Set Protocol.

The Future

Despite the pervasive bear market, the amount of ETH locked in DeFi products has grown from around 50,000 ETH at the beginning of 2018 to nearly 3,000,000 ETH at the end of 2019. If the trend continues and the DeFi maximalists are right, this is just the beginning of a massive DeFi wave. True believers argue that the advantages of an open and decentralized financial system are simply too compelling to not capture trillions of dollars of value.