What is DeFi? The Coming DeFi Revolution
What is DeFi and how it is going to have a revolutionary impact on the daily life of nearly every person on the planet.
What is DeFi?
DeFi, or Decentralized Finance, is a set of financial services that are: built on top of decentralized systems (blockchains), enforced by software (smart contracts), and censorship resistant.
Why is this revolutionary? Consider what happens when you eliminate the need for all of the current traditional banking institutions (middlemen). Will they all go away? Probably not. Will this have a significant impact on the entire financial sector? Probably yes.
Examples
On Celsius Network, Dharma Lever, Nuo, and MakerDAO you can do the following, all without using a bank or a traditional bank account: deposit crypto and earn interest, borrow crypto.
Today, you can deposit crypto and earn interest, or borrow crypto, all without a traditional bank or bank account.
The amazing thing about this is that there is no bank involved! People can now lend and borrow between themselves without a middleman and cross border.
A person in Hong Kong can deposit DAI and earn interest, and a person in London can take a loan out using that deposit.
Tokenized assets are also an example of DeFi. A tokenized asset is an asset that has been tokenized on a blockchain allowing multiple parties to own a fraction of it. For example, a building can be tokenized. Why would you do this? See the why are people drawn to DeFi section below.
In short, DeFi tokenized assets allow people to invest in, trade, and securitize assets that normally cannot be easily invested in, traded, or securitized — all on a blockchain that allows for trustless, peer to peer, and lower cost exchange of value.
Broadly, another example of DeFi is simply the use of crypto as an alternative to fiat (country backed) currencies. This could be in the form of paying for goods or services or paying employees.
There are more advanced examples of DeFi (hedging, shorting, derivatives) that are not covered in this article.
Why This Matters
Are you worried that a bank or the government will freeze or seize your assets? Are you concerned the value of your savings account will drop dramatically? Where you turned down for a loan you needed to start or grow a business?
If you live in a stable country, you may not be concerned or have issues with asset seizure, inflation, or loan availability.
But consider the situation of the average Venezuelan right now. Inflation has reached an estimated 80,000% and people are having serious issues buying food. The use of Bitcoin there has grown significantly in the last few months.
Or, imagine that you were a Jew during WWII, or a Bosniak during the Bosnian Genocide. Of the many atrocities these people groups endured, asset seizure was one of them. What would have happened if the Jews or the Bosniaks had access to convert their local fiat money to crypto? Or if they could have sold assets and stored their value in crypto.
What if you do not have a bank account or are unbanked? The US FDIC estimates that there are 10 million people in the United States that are unbanked or underbanked. According to Mckinsey, “2.5 billion of the world’s adults don’t use banks or microfinance institutions to save or borrow money.”
If you don’t have a bank account, it is difficult to participate in normal financial transactions like credit, savings, insurance, and payments.
Why are People Drawn to DeFi?
People find value in DeFi for a number of reasons.
Alternative to traditional banking — according to a Facebook IQ white paper, 92% of Millennials don’t trust banks. In the crypto world, creating a new “bank” account (crypto wallet) takes seconds and does not require anyone’s permission.
Be your own bank — with DeFi and crypto you control your assets, you decide when/how to deposit/lend/borrow against, and no one can freeze or seize your assets.
Rapid settlement — transactions (payments, loans, etc) settle in minutes or less, instead of days.
24/7 access — you don’t have to wait for a bank branch to open, or wait for equities markets to open.
Cost/Fee reduction — with the middlemen (read: banks) removed, the fees are reduced and in some cases removed.
Current Problems
DeFi is not without problems. Current problems include a lack of regulation or regulatory clarity and fiat on/off ramps, to name a few.
If a blockchain company based in the US facilitates a crypto loan to a resident in India, does that make them a bank? What about MakerDAO and DAI? You can deposit ETH (Ethereum) and withdraw DAI in a collateralized debt position (CDP) using the Dai Credit System. How is that regulated? Many hope in the least way possible.
Another major problem is fiat on/off ramps for crypto and fees. There are very limited services that will allow/help you convert fiat money to crypto. Coinbase being one of the few in the US.
Generally, unless you use a peer to peer service like LocalBitcoin or LocalEthereum, you will pay 1.5%+ to buy crypto with fiat currency (USD, EUR) and 1.5%+ to sell crypto and convert back to a fiat currency. See Coinbase fees. And this does not account for the spread the companies take (the difference between the current open market value of the crypto and the rate they will convert it for you).
What is Coming
What does the future look like for DeFi, what is coming?
Today, for the most part, you can only transact with a limited number of crypto currencies for lending or borrowing (ETH and DAI for example). In the coming future you will be able to transact using a larger variety of collateral. For example, MakerDAO, will be soon accepting many different cryptos as collateral. The vision for the future of DeFi is to allow for any kind of tokenized asset (buildings, art work, collectibles, etc) to be used as collateral.
Imagine taking that rare and significantly valuable baseball card you have had since you were a kid and using it as collateral for a loan.
More efficient and lower fee on/off ramps for crypto are coming. As the use of stablecoins (USDC, DAI) become more common there will be easier ways to convert fiat currencies to them. Then once you have a public blockchain based crypto (USDC, DAI) you can trade it for other cryptos and transact with it.
As an example of movement in this area, IBM recently announced that six global banks have signed up to issue stablecoins on IBM’s now-live blockchain network.
And BTW, nearly every person on the planet? Ok, so maybe I exaggerated a little, but my hope is that it truly is nearly every person on the planet that can take advantage of DeFi — and that it can increase economic opportunities and significantly reduce poverty.
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