DeFi stands for Decentralized Finance.
This term refers to financial services provided by decentralized platforms, i.e., not controlled or managed by a single entity, but by a public and open computer protocol. When the decentralized Bitcoin protocol was proposed in 2008, it was created to make Bitcoin a tamper-proof currency, not controlled by anyone, but managed only by a public and open computer protocol, to prevent manipulation.
Since then, the bitcoin protocol has proven to be very effective in this regard, not least because it has never been manipulated or hacked, and has not been subject to forgery or counterfeiting. Because the decentralization that made it all possible worked so well for bitcoin, there have been attempts in recent years to exploit it even in financial services. This is because bitcoin itself is only a digital currency and its protocol does not, for example, natively include smart contracts.
Whereas on the Ethereum network, which is based on a decentralized architecture similar in many ways to Bitcoin, smart contracts are natively supported, allowing decentralized programs to be written and executed that can create financial transactions autonomously. With these smart contracts, it is possible to create decentralized financial tools based on public and open networks such as Ethereum, which are capable of providing financial services with unprecedented features.
Obviously, in addition to the benefits, DeFi platforms also have some limitations. This is where CeFi (Centralized Finance) platforms come in, tackling the remaining part of digital financial services.
DeFi tools have certain advantages:
First, they cannot be manipulated, meaning that once a smart contract is uploaded to the Ethereum network, it cannot be modified, stopped, altered or counterfeited. It will simply function forever in the way it was designed. This makes it immutable, which means that if someone wants to modify it, or perhaps upgrade it to a new version, it is necessary to create another smart contract and move all assets to the new one.
Second, they are completely predictable, meaning that their behavior always follows the instructions contained in their computer code. Of course, the downside is that there is no room for flexibility: the behavior of these tools is cold and unforgiving, since they do not allow actions that differ even slightly from the code.
Third, they are publicly verifiable by anyone. Thanks to any public blockchain explorer, and the fact that they are open source, anyone can access the code and check in detail how everything works.
These features make DeFi tools absolutely unique, as never before has it been possible to create financial platforms that cannot be manipulated in any way, that cannot be restricted, hindered or stopped, and that are completely predictable and publicly verifiable by anyone. However, the downside is that these features do not allow these platforms to provide all financial services.
For example, in the lending sector, DeFi platforms are already widely used, specifically in the cryptocurrency sector, precisely because they are extremely safe and predictable, but they require collateral covering at least the entire amount borrowed. This means that they cannot be used to make loans that rely solely on trust, or the prospect of future income, such as bank overdrafts or loans not secured solely by a document such as a paycheck.
DeFi cannot be a complete substitute for CeFi.
In short, decentralized finance cannot be a complete substitute for traditional finance, but it can provide services that traditional finance has never been able to provide.
In particular, the trustless nature of DeFi tools, which do not require users to trust them since their behavior is absolutely predictable, tamper-proof and publicly verifiable by anyone, makes them something completely new.
This real revolution was started by bitcoin, the first trustless currency in history, which does not rely on trust in the subject that issues and manages it, simply because that subject does not even exist. There is a well-known motto for decentralized financial tools: "This motto clearly illustrates that you don't have to trust anyone to use them, because you only have to check personally that everything is as it should be.
As such, DeFi tools are definitely different from CeFi tools, although they offer similar financial services, such as loans. In addition, they also offer completely new financial services, such as algorithmic stablecoins. On the other hand, centralized finance tools (CeFi) always require the existence of a single management entity or at least a limited group of entities with more power than the simple users. This is sometimes a disadvantage, but it can also be an advantage, such as knowing who to contact for explanations or help, whereas for DeFi tools it is much more difficult to get help from third parties in a secure way.
Explore the combination of DeFi and CeFi
For example, when one loses access to a decentralized portfolio, there is no way to recover it, whereas if one loses access to a centralized portfolio, in theory, it should always be possible to get help from the centralized portfolio manager to recover access.
All traditional financial tools are centralized, the reason being that there has always been a party providing and managing them. The ability to eliminate the provider makes their use much more secure, as there is no need to trust. In addition, it also means that there is no need to use intermediaries to take advantage of financial services.
In centralized finance, the most popular intermediaries are banks, without which many traditional financial services simply cannot be used. In contrast, in decentralized finance, there are no intermediaries, which makes it possible, for example, to obtain loans from individuals without having to use a banking or credit institution. Indeed, it is the decentralized computer platform that provides the service, and not an institution composed of people who may make mistakes or act in an unfair or even criminal manner.
DeFi is therefore a novelty, and a great innovation, but it does not solve all the problems of the financial world and will not make CeFi disappear.
On the contrary, DeFi and CeFi will contribute in a complementary way to offer users innovative financial services that already allow them to do things that, even ten years ago, were unimaginable.
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