DeFi is a trendy shortened version of the term “decentralised finance”, and to better understand what it means, let us compare it to “centralised finance”, or CeFi for short.
Centralised finance is easier to understand, as that’s how financial systems work at the moment and have worked for the past few decades, that’s what we’re used to, that’s how we know it. With all its good and bad features. CeFi is expensive and not very efficient, and there are administrators involved.
But it has a more serious problem than costly operation: it is unreliable. All of us probably already had one the following experiences: our account got blocked, been banned from something, been unable to access our money, had to wait for IT maintenance, or the IT system being hit by a DoS attack – shall we go on? But the Russian invasion of Ukraine has taken CeFi’s unreliability to a new level. For purely political reasons, politicians have cut off tens of millions of people from their usual credit card networks overnight. They have caused serious harm to tens of millions of members of the community, without them being able to do anything about it. This has been a warning, anywhere you live, this may also happen to you.
Moreover, CeFi or centralised financial systems are seriously outdated and therefore operate with high fees and low efficiency. The technological development seen over the past decade has enabled the development and emergence of a new decentralised financial world.
DeFi is a low-cost, fast, efficient, reliable and fully transparent global financial ecosystem, operating without any central authority, and globally accessible.
Now imagine a new global financial system with features such as efficiency, transparency and accessibility that are often annoyingly missing from the current system. So how would this be possible? Using the newly developed cutting-edge technology, which is blockchain.
Traditionally, banks are supervised by supervisory authorities, which are run by governments. But in the future, DeFi will allow the entire financial world to work differently, using blockchain technology.
What is decentralisation?
On the one hand, decentralisation means that instead of being stored in one physical location, such as a central computer in a bank, data is stored in multiple locations on multiple computers around the world. On the other hand, decentralisation also means that no single person, company, government or authority can influence any aspect of the data recording and storage process. An important pillar of the system is that blockchain allows the decentralisation of transaction data management across a network of computers around the world using open-source software. This means that all data will be on all computers.
The next pillar of blockchain technology is “transparency”. Transparency means that all the data in the distributed ledger of public blockchains is available to everyone via a blockchain reader software.
The third pillar of blockchain technology is “immutability”. Immutability simply means that the data stored and recorded on the blockchain cannot be modified or falsified. Any change to the blockchain requires that a majority or even all of the data storage computers approve the change through a consensus process. This mechanism makes it impossible to alter or falsify data.
How is this possible?
By a smart contract. Okay, but what is a smart contract? The term “smart contract” was coined in 1998 by Nick Szabo, a US computer scientist, legal scholar and cryptographer who invented the digital currency “bit gold” 10 years before bitcoin was created. Szabo’s idea was to basically use computer code to execute sophisticated contract terms, when buying and selling securities and futures. So smart contracts are “simply” lines of code that set out the terms of a contract and regulate its execution. Smart contracts have the unique ability to authorise transactions and enforce contract terms, making central authorities such as governments, banks or courts unnecessary. Smart contracts thus make transactions traceable, transparent and permanent.
The DeFi movement aims to replace the current financial system with a more transparent and reliable system.
So what do you think about DeFi? Do you think the DeFi project offers the greatest potential in the crypto world?