Technology moves quickly. In fact, not only does it move quickly, but it’s accelerating, and one thing about new tech is that there’s usually a lot of jargon and new terms. Some of it makes sense, and some is a little harder to figure out.
One new term you might have heard recently (or if you haven’t yet, then you probably will soon) is DeFi. You’ll come across this phrase if you dive into bitcoin, cryptocurrencies, or blockchain technology in general, and it sounds intriguing but isn’t always clearly defined. Let’s think about what DeFi is, and what it might be used for in the near future.
What does DeFi Mean?
The word DeFi refers to decentralized finance, but is a lot quicker to say. Decentralization is one of the core principles of bitcoin and cryptocurrencies. Initially, beginning with bitcoin itself, the idea was that it was to be an entirely decentralized currency. That means no central bank, no middlemen, and no government interference, and in their place a trusted, secure network enabling peer-to-peer transactions. If it sounds idealistic, that’s because it is: bitcoiners are ambitious and genuinely committed to making the ideal into a reality.
After bitcoin came other cryptocurrencies, most notably Ethereum, which created something akin to a decentralized computer network, utilizing blockchain protocols and enabling further forms of decentralization. What we now see (with Ethereum and other blockchain protocols) is a move towards an entirely decentralized web, known as Web 3.0, and with that, decentralized finance, including borrowing and lending, acquiring a crypto mortgage, and trading a vast range of digital tokens and currencies.
Borrowing and Lending
As mentioned above, DeFi allows for peer-to-peer lending, in which participants set their own terms and don’t have to ask permission from any higher levels of management, since there are no higher levels of management, and nobody acting as either a go-between or a gate-keeper. These arrangements are facilitated by the use of smart contracts. What this means is that the terms of any agreement are coded immutably onto the blockchain, and terms will be initiated when conditions are met. In this way, both parties can trust one another without the need for a central authority.
Simple Payments
Again, smart contracts are integral to this function. As the code itself can execute outcomes when a payment is processed (and the conditions of the contract for a sale have been met), the product can be released to the buyer automatically. DeFi does away with the need for escrow services and simplifies much of the selling process. This kind of system is already in use on NFT marketplaces, where digital art and collectibles are traded.
Asset Management
With traditional finance and asset management, you are relying on third parties to secure and verify your assets. However, with DeFi and blockchain technology, you are in total control of your own assets, and the ownership of those assets (or, more specifically, of the wallet that contains those assets) is independently verified in code and immutably, on the blockchain. Basically, again, there’s no central authority, and you are in charge of your own assets.
Blockchain Gaming
While we’ve had online gaming for some time, what we’re headed towards now is blockchain gaming. This means games taking place in online environments that are always active, and which feature digital assets that can be bought and sold, and taken from one digital environment to another. In other words, assets belong to the player, even outside the game. This is done through the blockchain technology that is integral to DeFi, and shows how the boundaries between finance and gaming are blurring. This is especially apparent when you consider play-to-earn games, in which players are accumulating in-game cryptocurrency that can be converted to fiat and cashed out.
Are There any Risks?
As is the case in general with crypto, there are a few things that users of DeFi must take into consideration and be careful about. Firstly, this is an extremely new and still developing area, and there are a lot of competing platforms. Compared to traditional financial institutions, there are far fewer guarantees of stability, and you cannot be sure which platforms are going to survive long-term. Before putting any money into DeFi, do as much research as you can, paying close attention to how many users a platform has, who it was set up by, and what its reputation is like.
Additionally, be aware that you are in total control of your crypto wallets and your assets, and so it’s entirely up to you to make sure that you don’t make any mistakes, or lose any keys, or in any way fail to keep your finances secure. If you make an error that leads to financial loss, then you are unlikely to be able to recover anything that’s gone.
DeFi is a turbulent, evolving ecosystem that is filled with innovation and potential. Take every precaution, but at the same time, enjoy exploring and see where it can lead you.