Intro to DeFi
Why the $GME mania is a giant endorsement of decentralized finance and the underlying blockchain technology to replace the current settlement systems.
The wild rally of Gamestop stock and other meme stocks stole the headlines in January, formulating various narratives on the social class divide (the masses — r/WallStreetBets vs. the establishment —hedge funds, Wall Street). The frenzy exploded when Robinhood and other brokerages placed temporary limitations on trading activity, spurring up conspiracy theories regarding Robinhood’s relationship with Citadel (who also bailed out Melvin Capital due to the GME short squeeze). Conspiracy theories aside (which is already drawing regulatory scrutiny from Washington), this situation highlighted the complicated plumbing underneath the stock settlement process. For those interested, @compound248 on Twitter gave a detailed primer on the entire process:
DeFi: Decentralized Finance
So how does this relate to DeFi?
DeFi — or decentralized finance — is an ecosystem of distributed financial applications built on blockchain, which means that there is no single governing authority. This addresses both problems exposed by the Gamestop rally. First, blockchain technology can reduce the current T+2 settlement time via smart contracts to seconds from days. Secondly, due to the distributed nature of blockchain systems, no entity can singlehandedly block trades or close positions like various brokerages did to mitigate their risk during the meme stock frenzy.
Besides the problems highlighted by the current situation, centralized financial systems also share some flaws:
- Payment networks are slow and expensive: We now know about the T+2 settlement time in stock markets, but also in retail operations, sending money to different countries is not only slow but riddled with fees. Despite its name, the current infrastructure based on the SWIFT payment system (international…