The world of fintech is becoming increasingly rich in acronyms. DeFi is one of the contractions that should be remembered in the coming years because it adds a deeper perspective to the world of finance.
Behind Decentralized Finance (hence DeFi) lies an innovative way of thinking that does not accept monopolies. Instead, it is based on openness, free competition, and collaboration.
This alternative financial system, based on blockchain technology, is characterized by an open infrastructure. This structure intends to meet the many limitations posed by the traditional financial system.
Introduction to DeFi: What is it?
When we talk about decentralized finance, we refer to the organization of services like banking services but do not have any hierarchy. This could be the blockchain, the vital thing being less centralized than the banking system.
Today, DeFi can also be understood as a natural movement born to bypass the traditional scheme in which banks are in control. DeFi offers classic banking services without any traditional mediums.
Introduction to DeFi: A New Revolution in Finance; A limited current financial system
Created at the beginning of the IT age, our current financial system is based on an infrastructure that has become obsolete. Finance has not benefited from the revolutions brought about by the Internet: it still rests on a rigid base, whose limits appear more and more glaring.
Thus, the current financial system is a natural oligopoly (a market structure in which a market or industry is dominated by a small number of large sellers or producers), in which a few powerful financial institutions share the pie. The concentration of power, corruption, repeated scandals (banking and economic crisis of 2008, Madoff case, Archegos case, to name but a few): the least we can say is that this system in isolation has many limits.
Moreover, the banking system as we know it is present only in developed countries. According to a recent study conducted by the World Bank, 3.8 billion adults worldwide have a bank account. That’s more than 3 billion people “unbanked.”
This constrained dependence on an opaque financial system comes at a cost for customers. Not only do they have to deal with the goodwill of the actors in the financial system, which is a waste of time and efficiency, but they also suffer from the slowness inherent in this system.
In addition, the costs incurred by the presence of intermediaries (various and varied fees, interest rates, etc.) are directly passed on to consumers.
Finally, and perhaps most importantly, the current financial system remains utterly opaque in a world that has made transparency an important value.
Who knows where and how their money is invested?
Who knows precisely what activities are financed with their savings?
Moreover, who decides the conditions under which we can use our money (we think, for example, of the withdrawal limits imposed by banks)?
This lack of transparency means that consumers are ultimately not controlling their money.
Introduction to DeFi: Offers a fully decentralized financial system
In the digital age, the next revolution may well come from DeFi. Above all, it aims to recreate the financial ecosystem we know today by removing trusted intermediaries such as banks. The goal? Break down barriers to entry and provide everyone with the same financial services and products.
Introduction to DeFi is defined by three main characteristics: digital, decentralization, and openness to all, both in use and creation.
It competes with the current banking monopoly by offering a fully decentralized system that opens access to all financial services and products (means of payment, loans, savings, investments, etc.) anonymously and securely.
In practice, this means that anyone can, for example, access loans from home. Even people outside the banking system can access it. Therefore, it is a system resistant to censorship: no entity and no individual can thus oppose a transaction between two consenting parties, the will of the latter being law.
Concretely, the idea is to recreate financial services and products decentralized, without recourse to any intermediary. Smart contracts, thanks to blockchain technology, thus replace your banker. And since intermediaries are absent from this system, all ancillary fees and commissions disappear.
For a loan, for example, it is a question of requesting a credit on a platform in exchange for collateral, that is to say, the deposit of a mortgaged amount (which will be sequestered in a smart contract). The collateral acts as a guarantee, making it possible to remove the usual limits and requirements.
So, it is no longer necessary to justify a permanent contract with the ended trial. This lack of barriers to entry recreates a transparent, fair, and instantaneous financial ecosystem.
Today, many exchange platforms allow you to take advantage of the benefits of the Defi. And we can bet that this thriving ecosystem is still in its infancy. Between January and August 2021, DeFi grew from $15 billion to $80 billion. We can easily imagine what will happen in the next few years…
New players are accelerating this revolution by creating and making accessible the tools to develop new decentralized finance. It is up to us to imagine all that can be done with it.
An introduction to DeFi: More pragmatic than ideological
Realistically, DeFi remains an umbrella term covering fintech solutions ranging from financial computer protocols to crypto derivatives. This “blockchain” finance globally promises cheaper and more open access to banking, insurance, loans, etc.
And this is precisely by reducing the costs and risks associated with the use of centralized intermediaries thanks to blockchain technologies and cryptography. The phenomenon, therefore, promises interoperability between blockchains that could help break down silos in the financial sector and significantly promote innovation there.
More than a trend, a likely forced march that pushes more and more classic players to embark on the crypto universe, and a superior segment of FinTech is DeFi.