Cryptocurrencies and the blockchain space can be a confusing area for a newcomer to dive into. One thing that a lot of people want to know at the beginning, before throwing in any money, is what the practical use cases of the technology are going to be, beyond financial speculation?
That’s a broad question that could elicit a multitude of answers, depending on who you ask. But a good place to get started, if you want to explore an area of blockchain that’s loaded with potential and already up-and-running, is the world of decentralized finance, or DeFi.
What exactly is DeFi?
Take a moment to think about the traditional financial structures we’ve all grown up with. It’s not often people give this framework much consideration, since it’s all around us and we’ve never been offered a functioning alternative. What you’ll see, is that it operates around hugely powerful central authorities, and an interlocking array of middlemen.
Now consider what blockchains can do, and what’s coming in the future of cryptocurrency. You only need to look at the de in Defi—decentralized—to get a sense of what DeFi does. Basically, it removes the central authorities, and cuts out the intermediaries. DeFi enables a financial system in which transactions are carried out peer-to-peer and trustlessly, without the need for permission from a bank.
By the way, in crypto, trustless means that there’s no need for a third party to be involved in any transactions. Simply put, in DeFi, you, and you alone, are responsible for your own finances, with all the fairness and flexibility that allows, but also, with the knowledge that if something goes wrong, no-one will bail you out.
To get a sense of the extent to which interest in DeFi is growing, consider that between 2020 and 2021, the total value of funds locked into DeFi protocols grew from around $10 billion, to around $100 billion, and we’re still only just getting started.
What are the advantages of DeFi?
First of all, as mentioned, it’s peer-to-peer. When bitcoin came along, it introduced the idea of direct digital payments, potentially removing the need for banking services or cash.
DeFi exchanges (DEX) are up to now primarily on the Ethereum blockchain, which was created after Bitcoin, and has smart contract capacity, meaning that its currency, ETH, operates as a programmable medium of exchange. DEXes are indeed decentralized and peer-to-peer. You don’t need permission to lend, borrow, or exchange, and there is no chain of intermediaries each taking their cut.
What this all comes down to, is this: do you want freedom from banks, lenders, and intermediaries? If so, then sign up at a DEX.
Furthermore, DEXes are truly accessible to all. The routine of asking for permission and being checked over by credit agencies simply isn’t a part of DeFi. For all that high street banks like to throw around notions of inclusivity, crypto is open to all, without jumping through hoops.
In addition, DeFi opens up possibilities as both a borrower and a lender. You can make your assets work for you, on your own terms, as and when you need, and you can access credit avenues when you require. It’s a symmetrical arrangement. Not everyone has the same assets, but everyone is operating on a level playing field.
One more interesting aspect is the decreased likelihood of mismanagement. DeFi runs on code, so as long as that initial code is good, then the system will work with absolute consistency.
What are the drawbacks?
Depending on your perspective, some of the advantages could be reframed as drawbacks. Let’s take the lack of a central authority, and the resulting freedom and responsibility over your own decisions. What this also means is that if you make a mistake, then you will have to accept the consequences, and there is no manager to whom you can complain and ask for assistance.
Then there is the issue of scalability. This is a particular issue for Ethereum, which has at times run into real performance issues, especially with regard to its fluctuating and at times hugely expensive gas fees (costs to have something done on its blockchain).
However, there are other blockchains in the space besides Ethereum, which appear to scale well, and on which DEXes are coming soon. Cardano has incredible potential now that it has enabled smart contracts, so expect challenges to Ethereum’s dominance. And on top of that, Ethereum itself is working on scaling solutions.
Where there are problems, there are fixes, and crypto is an ecosystem with no shortage of players, and in which things move fast.
One other issue that could be seen as either a pro or a con, is the notion of uncertainty, and stepping into the unknown. The crypto markets are volatile, new tech can be exceptionally good and still not gain acceptance, and the blockchain space is young and not widely understood.
Whether you look at crypto as exciting and transformative, or as perilously unpredictable, depends entirely on your point of view.