As cryptocurrencies and blockchain technology become more and more present in various sectors of the market, there is a lot of talk about decentralized finance, or DeFi. This is a broad term that represents a variety of applications and projects involving smart contracts and blockchain. Complex? Don’t worry, we’ll explain in more detail what DeFi is in this text.
Decentralized finance is an umbrella term that encompasses a variety of applications and projects in the blockchain open space without having a central governance authority . Essentially, this use of technology skewers the world of traditional finance in multiple ways, enhancing the digital movement of money and creating totally new tools.
Before we delve into this, we need to talk a little bit about cryptocurrencies and what they mean to the financial system. In 2009, bitcoin (BTC) was created as the world’s first digital currency. The initial aim of the project was to form a global payment and money transfer system . However, price instability became a serious obstacle that hampered the practical use of cryptocurrency.
Even so, the basis of bitcoin technology, the blockchain , continued to be studied and applied in the most diverse projects to become the pillar of digitization of global finance. Hence the rise of decentralized finance, a term best known for its abbreviation DeFi.
There are also some ideals behind this name. Decentralized finance literally wants to decentralize the current economic system, automating many processes by taking governance out of the hands of a few powerful institutions. This is called “ self-governance ”, supported by communities, foundations and institutes that guarantee its maintenance when necessary.
In practice, DeFi is many things, like financial applications built inside blockchain networks, usually made possible by so-called “ smart contracts ”. These smart contracts are automated agreements that don’t need intermediaries to execute and can be accessed by anyone with an Internet connection.
This technology is applied in decentralized applications, platforms or other software that use point-to-point protocols and developed in blockchain to, for example, facilitate the loan of money or the trading of digital and traditional currencies.
Most DeFi applications are built inside the Ethereum network, but many alternative public networks are emerging, offering superior speed, scalability and security, all at lower costs.
How did DeFi get started?
DeFi was developed from the idea of creating a financial system that is open to all and that minimizes the need to trust and rely on a central authority. It is argued that decentralized finance started in 2009 , with the launch of bitcoin. Through the first cryptocurrency, the idea of introducing transformation into the traditional financial world using the blockchain became an essential step in the decentralization of financial systems.
The launch of the Ethereum network and, more specifically, smart contracts in 2015 is what made all of this truly possible. This blockchain network maximized the potential of this technology in the financial sector. She encouraged the market and companies to build and implement projects that would eventually form the DeFi ecosystem.
Since then, a multitude of opportunities have emerged to create a transparent and robust financial system that no single entity controls. But the real milestone for decentralized financial applications was in 2017, with projects that enabled even more functionality beyond the simple transfer of money.
What is decentralized finance for?
There are already platforms that can do things difficult to imagine in the world of traditional finance, all automated, decentralized and without the direct involvement of banks. Some examples are:
- Cryptocurrency Loans
- Borrow cryptoactives (with interest receipt)
- programmable investment
However, it is important to say that this technology, like any other, has flaws and needs to be improved over the years. One of the biggest criticisms of decentralized finance is how criminals take advantage of it . There are already many cases where hackers managed to take advantage of some flaw in smart contracts to steal cryptocurrencies, for example.
That was the case of Poly Network , a platform that was hacked in August 2021. At the time, a hacker stole US$600 million in several cryptocurrencies by taking advantage of a loophole in a decentralized network’s intelligent contract.
That said, the DeFi ecosystem is gradually catching up with the traditional financial system, and despite the obstacles, the world of decentralized finance continues to move into the future. Eventually, this “alternative” feature in finance is expected to become dominant.