DeFi is defying everything we know about money

Decentralised finance, or DeFi, might have a remarkably boring name but promises a range of game changing technologies, applications and services that have the potential to completely revolutionise everything we take for granted in the world of money. Borrowing money, lending money, investing money, sending money, receiving money, insurance, even betting, the growing field of DeFi can transform it all.

Image Source: Photo by Mathieu Stern on Unsplash

Here, we attempt to explain DeFi to fictional Gen Z stalwart, keto influencer and Riverdale blogger, Lukas Shane Bradley.

LSB: I know Bitcoin is a thing, my mate Jay made, like, 40 grand on it, so what is DeFi?

TC: Bitcoin is a crypto currency, it’s a token of value, just like the Australian Dollar or British Pound. Decentralised Finance or DeFi is the broad term given to a whole host of decentralised applications that use blockchain technology to transact without a central authority or intermediary. DeFi is the name given to all the different projects that essentially remove the middleman from financial transactions.

LSB: Central auth-o-what-y?

TC: In our current financial system, we use centralised structures to do what we want to do. If we want to pay for something with a credit card, we use credit card payment providers like Visa and Mastercard to process the transactions and banks like CommBank or ANZ to hold and release our money. If we want to borrow money for a car or holiday or home, we look to those same banks and big lenders to give us that money. So, everything we want to do, whether that’s pay someone, transfer money, borrow or lend is dependent on these centralised institutions. There’s a lot of inefficiencies with that structure: everyone takes a cut and the payer or payee has to pay for it, the controlling institution can block the transaction if they want, not to mention time delays for processing. DeFi attempts to remove these institutions and their inefficiencies to let individuals or groups transact directly with other individuals or groups. It was originally thought this would help open up banking services to millions of ‘unbanked’ people worldwide (small businesses or populations of developing countries, for example, who might not have bank accounts but do have smartphones).

LSB: But how can it do that? Won’t everyone just run off with each others’ money?

TC: That’s where smart contracts come in. They’re the backbone of DeFi. They’re automated, unbreakable contracts written in computer code that set out the conditions for any transaction and automatically execute it. They’re also recorded on the blockchain which means there is a permanent record of every transaction. With smart contracts, individuals can act like big institutions.

LSB: OK, that kinda makes sense. So what does that actually mean for my life? Like, what can I dowith all that?

TC: With DeFi platforms like Compound or Aave, you can borrow cryptocurrencies to pay for things or invest further and pay them back with an interest rate or you can lend crypto currencies to those looking to borrow to earn interest for yourself. You can use a platform like Augur to bet on the outcome of events – sports, politics, economics – and avoid the fees and spreads of betting agencies and bookies. You can invest in virtual versions of real world assets like currencies (Australian Dollar, US Dollar, GB Pount, etc.) or precious metals with platforms like Synthetix and avoid the costs and delays in regular trading. You can even take part in a lottery on PoolTogether, where everyone gets their money back and the winner wins all the interest that has accrued in a shared investment pot. With all these applications transacting billions of dollars, funds have been established to allow investors to have exposure to a range of DeFi applications rather than participating in just one. Bitwise’s DeFi Crypto Index Fund, for example, invests in a variety of different DeFi platforms and lets investors buy units of the fund with non-crypto currency.

LSB: Sick. That sounds awesome. Is there a catch?

TC: DeFi is still a relatively new field with a lot of money sloshing around in applications that are often complex and hard to understand. There have been a few major cases of fraud and hacking resulting in big losses but they are the exception and not the rule. There is also the risk that smart contracts might have something malicious written into them that one party isn’t aware of so they’re not yet entirely failsafe. At the same time, DeFi works on the Ethereum blockchain which can currently have speed issues. At the moment, the Ethereum network can process just 15 transactions per second (compared with Visa’s 24,000 transactions per second) but a new version of Ethereum (2.0) is expected to solve a lot of these problems.

LSB: So then why are you telling me about it?

TC: The middle of 2020 was called the ‘DeFi Summer’ as there was an explosion in the number of DeFi projects and applications. In the last few weeks, however, the value of all money in DeFi projects dropped from $88 billion USD to it’s current value of $60 billion USD as the value in the crypto assets being poured into them dropped. Even with that dramatic reduction, the future of DeFi looks bright with Forbes writing that “the next phase of DeFi should make the industry more accessible to everyday users while building even greater trust… that clearly identifies risks to its users.” More and more institutions are seeing the writing on the wall and trying to get involved in DeFi projects driving even more momentum to adopt this new approach to financial services.

So, while the original goal of giving banking access to the ‘unbanked’ seems to have been overtaken by tech-savvy investors and speculators, there is hope that DeFi is on the right path to disrupting and revolutionising traditional financial systems. The DeFi future is a financial system that is more liberalised and decentralised than ever before, hopefully to the benefit of all those that use it!

LSB: Riiight. Thanks Current. You’re pretty smart for a fortnightly trend watching publication.

It’s actually The Current, but all good, you’re still welcome Lukas Shane Bradley. We had great help from The Conversation, CoinDesk, Forbes and BCG Plantinion. So tell us, which of those is actually your first name…?

Raph Krell