As cryptocurrencies and blockchain technology become more and more present in various market sectors, there is a lot of talk about decentralized finance, or DeFi. It is an umbrella term that represents a variety of applications and projects involving smart contracts and blockchain. Complex? Don’t worry, we’ll explain it to you in more detail. what is the challenge in this text.
Definition of decentralized finance, or DeFi (Image: )
Decentralized finance is an umbrella term that encompasses a variety of applications and projects in the open blockchain space. without having a central governance authority. Essentially, this use of technology pisses off the world of traditional finance in myriad ways, improving the digital movement of money and creating entirely new tools.
Before we dive deeper into this, we need to talk a 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 objective of the project was to form a global payment and money transfer system. However, price instability has become a serious obstacle that has hampered the practical use of cryptocurrency.
Even so, the foundation of bitcoin technology, the block chain, has continued to be studied and applied in the most diverse projects to become the pillar of the digitalization of global finance. Hence the emergence of decentralized finance, a term better known by its abbreviation DeFi.
The Blockchain network is supported by the processing of multiple computers around the world (Image: Tumisu/Pixabay)
There are also ideals behind this name. Decentralized finance literally wants decentralize the current economic system, automating many processes by removing governance from the hands of a few powerful institutions. It’s called “self-government“, supported by communities, foundations and institutes which guarantee its maintenance when necessary.
In practice, DeFi is many things, like financial applications built within blockchain networks, usually made possible by what are called “smart contracts”. These smart contracts are automated agreements that do not need intermediaries to execute and are accessible to anyone with an internet connection.
This technology is applied in decentralized applications, platforms or other software that use peer-to-peer protocols and built on the blockchain to, for example, facilitate the lending of money or the trading of digital currencies and traditional.
Most DeFi applications are built within the Ethereum network, but many alternative public networks are emerging that offer greater speed, scalability, and security, all at lower cost.
DeFi was developed from the idea of creating a financial system that is open to everyone and minimizes the need to trust and rely on a central authority. It is argued that the decentralized finance started in 2009, with the launch of bitcoin. Through the first cryptocurrency, the idea of bringing transformation to the traditional financial world using blockchain has become 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 has maximized the potential of this technology in the financial sector. She encouraged the market and businesses to build and deploy projects that would eventually form the DeFi ecosystem.
Ethereum is the preferred blockchain for creating smart contracts (Image: Executium/Unsplash)
Since then, a plethora of opportunities have arisen to create a transparent and robust financial system that no single entity controls. But the real milestone for decentralized financial investments was in 2017, with projects that enabled even more functionality beyond just transferring money.
What is decentralized finance used for?
There are already platforms capable of doing things difficult to imagine in the world of traditional finance, all automated, decentralized and without direct involvement of banks. Some examples are:
- Cryptocurrency loans
- Borrow crypto-assets (with interest)
- mortgages
- programmable investment
However, it is important to say that this technology, like any other, has flaws and needs improvement over the years. One of the biggest criticisms of decentralized finance is how criminals take advantage. There are already many cases where hackers have managed to take advantage of a loophole in smart contracts to steal cryptocurrencies, for example.
Such was the case with Poly Network, a platform that was hacked in August 2022. At the time, a hacker stole $600 million in various cryptocurrencies by taking advantage of a smart contract breach on the decentralized network. .
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 forward into the future. Eventually, this “alternative” feature of finance should become mainstream.