You might recognize that glorious feeling of stumbling upon something new that is so interesting, exciting and inspirational that you simply HAVE to move beyond the point of having it for yourself. Well… it happened again.
Those who know me personally might recall that time I first learned about the notion of blockchain and crypto back in 2017, which pushed me to start writing content, co-organizing events and eventually start a career in the sector(yay!). Those who remember this might also be aware of the fact that today — almost two years past the crypto hype bubble of 2017 — most crypto prices are down about 88% in price (and I’m now absolutely numb to crypto price movements).
What would surprise you though, is that today I feel once again as fascinated and inspired by a topic that is actually built on top of blockchain/crypto. It’s called DeFi and I’d love to introduce you to the topic. In this piece, I’ll explain what it is, how it works and why I think you should absolutely know about it.
So, what is DeFi?
DeFi is short for Decentralized Finance and it refers to the ecosystem of protocols, platforms, apps and tools that are rebuilding traditional financial products outside of the traditional financial system. Instead of being offered by banks, DeFi solutions are built using open-source software and uncensorable networks. As a result, DeFi products are inherently transparent and open to anyone with a connection to the internet. The DeFi space enables people all over the world to engage in financial activities (such as spending, borrowing, lending, betting and trading) in a peer-to-peer fashion, without relying on intermediaries like banks and governments.
The growth of the DeFi space has been staggering, with over 675M USD worth of value currently being locked inside of DeFi protocols. I have closely watched this space evolve over the past twelve months and right now I truly believe that DeFi is turning into a parallel financial system that will co-exist with the traditional system of central banks, Santander, Deutsche Bank, and pension funds. Pretty much all DeFi solutions are built on top of Ethereum, the public blockchain platform that has by far the most activity in terms of development and active users.
How does it work?
DeFi solutions are powered by blockchain technology and leverage the most powerful feature of this technology: Programmable digital assets, such as bitcoin (BTC) and Ether (ETH). These digital assets have a monetary value, mostly because of their Store-of-Value characteristics. Since these assets are programmable, we can lock them in a smart contract and have them serve as collateral (similar to a house backing a mortgage).
We can then use the provably locked value to do all kinds of cool stuff! We can take out loans over this collateral in the form of a so-called stablecoin — a digital currency that maintains a value peg to a world currency like the USD (through a very complex but fascinating system called MakerDAO). We can then trade these stablecoins for other digital assets, spend them on the internet and lend them to lending protocols in order to earn interest. We can also do more advanced stuff that goes beyond the scope of financial products that we know today (I’ll write more about this later!)
The general idea is here is that digital reserve assets are used to collateralize innovative financial products that are fully digital and disintermediated. You interact directly with code, wherever and whenever you want, without the need for companies in between. It’s quite the paradigm shift.
Why is it better?
DeFi as a concept and as an ecosystem is still very premature, but it introduces us to a new model for financial services and money. A new model that is fully collateralized, transparent, uncensorable and composable. I’m not an economist by background, but to me, it’s quite clear that the global financial system has some inherent flaws that are mainly caused by opacity and excessive borrowing. Although I don’t see the global financial system being fully replaced by crypto-based alternatives, I do believe that it will exist in parallel and offer an alternative to those who seek it.
DeFi solutions also have some characteristics that are interesting from a user perspective. First and foremost it’s permissionless, which means I don’t need approval or permission of anyone in order to use these products. I also don’t need to create accounts everywhere, share copies of my passport or trust banks that my money is actually there. Instead, I interact directly with the code using my cryptocurrency wallet. Interactions are pseudonymous, instant and can be started anytime and anywhere. I could hypothetically take out a loan over my digital collateral whilst climbing El Capitan at 4am (although you do need an internet connection…)
Why does this all matter?
Well, let’s first consider that a big chunk of the world population does not have access to decent financial infrastructure. Billions of people don’t have access to banking services (eg. Ghana) and billion people are prone to financial censorship by governments(eg. China). The notion of DeFi is especially relevant to these people since it stands to offer them a permissionless and (mostly) uncensorable plethora of financial solutions that could help them grow their productivity, wealth and quality of life.
Let’s also consider those who are living in bad economies, such as Venezuela, Argentina, and Turkey. We’ve seen that SoV assets such as gold and bitcoin have been used to escape abysmal inflation rates of local currencies. What if a fully digital and globally available currency was available as an alternative? It could help them preserve their purchasing power whilst their local governments are fucking up the economy. At a conference in Osaka last month I attended an excellent talk of an Argentinian guy that has been using DeFi to escape his local economy for the past couple of months.
Those who are reading this probably do not belong to the groups I mentioned above. Neither do I. Why should WE care about this DeFi movement? Well, besides some practical improvements over traditional bank accounts and services, I believe that our generation is increasingly vigilant and skeptical towards the global financial system.
It might not be urgent yet, but in the (likely) event of another financial crisis, I expect many of us to seek financial freedom and sovereignty outside of the traditional financial system.
Let’s get started! Well…
…I’ll be realistic by saying that there are still a lot of challenges to overcome before the Decentralized Finance space can really take off and fulfill its potential of a global financial system. This doesn’t mean that you can’t start using it today! In fact, I highly encourage tech-savvy readers of this article to get familiar with the core concepts of using DeFi. Buy some crypto using Coinbase, install a mobile wallet like Coinbase Wallet or Argent, try to open a Vault in MakerDAO and then lend out your loaned stablecoin on Compound. It might take some time Googling, but you’ll get that “Aha!” and realize we live in interesting times. Don’t forget you’re dealing with cutting-edge technology, so proceed with caution and don’t put all your money in.
For anyone that knows me personally (or remotely knows me); consider me your buddy in Decentralized Finance! I’m open to any questions and I’d be happy to help you with getting started. For the month to come I’ll be taking on the role of DeFi advocate in my local communities and networks. Looking for an expert on the topic, a speaker or a panel member? Feel free to get in touch!
Peace and love,
Deniz (find me on the blockchain at 0xdeniz.eth)