DeFi is short for “Decentralized Finance” which is a term used to describe financial services or applications that use blockchain technology to perform the function of various components in the traditional financial system.
The objective of DeFi is to decentralize financial services. Decentralization is primarily made possible through smart contracts, which were pioneered by the Ethereum network. This decentralization will result in services not being controlled by any single, central source. This is especially important because in centralized systems, gatekeepers like humans can restrict control of a user’s money, limit transactions, and decide who is able to use or who is not able to use the services.
But with DeFi, there is reduced human influence and smart contracts are used as the primary tool to execute a transaction once the set requirements are met. Smart contracts also reduce the costs of creating and enforcing contracts by reducing legal costs, nearly eliminating costly contract disputes, and reducing the reliance on systemic trust and goodwill for establishing contractual relationships.
By building networks and systems of smart contracts, DeFi platforms are able to provide the basic services of banks, exchanges, and brokerages.
DeFi for the Unbanked and the Underbanked
When cryptocurrency was introduced, it enabled users to transfer their money anytime, anywhere without the need of a central authority providing approvals. This enabled people who previously had no access to the global banking system to engage with a global financial network.
For example, a talented digital artist in a remote Southeast Asian village can now sell his art to collectors all over the world, something he would have previously needed a bank account and passport for.
While many of us take basic services like national identification and bank accounts for granted, the World Bank estimated in 2017 that there are 1.7 billion people who have no access to a bank account, and that 40% of people in low-income countries do not even have a national ID. The lack of access to banking traps the poor in a cycle of poverty.
In the past, financial institutions oversaw transactions or contracts pertaining to loans, insurance, raising capital, crowdfunding, betting, and derivatives. This gave institutions a lot of control over who can purchase what and who cannot, and the cost of providing these services meant that financial institutions only had the incentive to serve those who had enough wealth to pay (directly or indirectly) for such services.
A large number of DeFi projects hope to be able to significantly reduce the number of unbanked people and disrupt the cycle of poverty. DeFi nearly eliminates the cost of administration for banking services, removes a large portion of the risk of corruption centralized systems, and much more easily accessible even in remote locations, since one would only require a device connected to the Internet.
Finance Without Borders
At another level, DeFi advocates hope for a disruption of technology and finance in which an individual can have full control of their assets and can use technology to collaborate directly with other people to produce wealth.
For most people, especially those in wealthy countries with well-developed economies, this is the attraction of DeFi. DeFi protocols already provide a range of financial vehicles and marketplaces where users are the sole custodians of their assets at any point of time.
When DeFi was first introduced, it was used to enable users to save, take loans and trade. As technology progressed, many new DeFi applications have sprung up and have become very popular.
One example is the WBTC or “Wrapped” Bitcoin. WBTC or “Wrapped” Bitcoin allows users to use BitCoin on the Ethereum blockchain. In the past, users had to swap or exchange BitCoin for Ethereum, to be able to use their funds on the Ethereum blockchain. With the integration of WBTC, users can now exchange 1 BTC for 1WBTC to be used on the Ethereum blockchain.
DeFi applications also introduced the concept of yield-farming. This allows traders who are knowledgeable and willing to take some risk to search for new opportunities and earn larger returns. There are also decentralized exchanges (DEXes), loan services like AAVE, and derivatives – all decentralized forms of traditional financial industry functions.
If you would imagine DeFi as a physical object, think of it as Money Lego. The composability of DeFi allows users to build almost any form of financial instrument possible. Like Huobi Earn, where you can deposit your cryptos and earn some interest based on your deposit in return.
Alternatively, check out Huobi PrimePool where you can lock in your BTC and earn other DeFi tokens in the process.
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