A Glimpse of A More Open Finance System
Traditional finance sucks. It operates on trust, which unfortunately isn’t always rewarded. Central authorities such as governments, banks, and institutions have been given power and control over the entire system. So far, they have only managed to destroy what little trust was left for them. Currencies that are supposed to underpin economies are either under or overregulated.
As we continue to hand over control of our money, we end up being controlled ourselves. Central authorities continuously gain power as more people place their trust in them. Yet, as investors, we don’t have any form of control or say over how these businesses manage our investments. Nor do we have any say over how our governments manage the economy. Corporate transparency has a long way to go and is not a priority for most traditional organizations.
And so, from the bowels of centralized finance, DeFi was born. More precisely, cryptocurrency was born as a response to centralized finance. DeFi is a response to both. DeFi is crypto 2.0.
DeFi is an abbreviation of decentralized finance, which typically refers to the digital assets, financial smart contracts, protocols, and decentralized applications (DApps) built on the Ethereum blockchain. It runs nodes and services around the world without a central service exercising control over the entire system.
Simply put, decentralized finance allows people to use financial systems without submitting verification documents such as IDs, social security numbers, or proof of address. If that isn’t revolutionary enough, it relies on software written on the blockchain to allow those involved in the market, such as buyers and sellers, to interact peer-to-peer without going through intermediaries, such as banks or brokers. These software require very little human intervention. Instead, smart contracts execute upon meeting their directives.
DeFi has many defining characteristics: it’s permissionless, interoperable, and transparent. It also allows for quick and efficient exchange of information, coordination, collective learning, and collective resolution. Suppose the main goal of cryptocurrency is to put power and control of money into the holders’ hands. In that case, DeFi aims to bring this to a macro level of institutions and organizations.
While DeFi shares many characteristics with cryptocurrencies, one of the most striking differences is its composability. Its open-source code allows developers to make Dapps on top of other applications. This doesn’t just accelerate innovation, but the interoperability allows for new products and services to be created through mixing and matching existing DeFi tools, so-called Money Legos.
Ironically, the most challenging characteristic to meet for many DeFi organizations is decentralization. As DeFi platforms are built to be managed by a community of users and not centrally controlled, the users become owners of their financial applications. They have control over every major decision, can propose changes, and benefit from the organization’s success. Conversely, the developers, founders, or any centralized party have neither control over the funds nor can they suddenly change the rules of the game.
MakerDAO, one of the earliest DeFi organizations, founded in 2015, recently announced it’s finally beginning its decentralization process this July. Giving up control over the smart contracts related to a project can put an organization in a hard place should there be any problems with the protocol that they need to fix unilaterally without going through an approval process from the community. This is particularly hard for protocols still developing their applications. In these cases, teams will often maintain some degree of control over their protocols. As a decentralized autonomous organization, Ubiquity plans for a fully decentralized government rollout as early as Q4 of this year. While not all DeFi apps are at the most decentralized end, they are working on getting there, with teams gradually relinquishing control over their protocols.
As we move towards a decentralized society, more and more DeFi apps with compelling use cases will sprout. There will be more demand for DeFi Dapps in the future, where decentralized applications will set the new standard for the economy. Consequently, the global economy could receive a considerable upgrade as individuals are taking a more proactive stance in controlling their finances. But, for now, decentralized finance gives the world a glimpse of a more open and transparent financial system.
