DeFi : A new financial paradigm

For centuries, financial and economic systems have been centralized around a set of legal infrastructures allowing, through responsible monetary policies, the creation of trusted reserves of value and the expansion of an ever growing financial sector facilitating the exchange of value between different market participants.
However, despite its robustness and its historical success, this conception of centralized finance has also some limits that we are currently witnessing in some countries like Venezuela or even on a smaller scale in the US. Indeed,  either in the case of the irresponsible monetary policies led by the venezuelan central bank or the lack of transparency from US centralized financial actors during the subprime crisis, the excess of centralization in each case lured economical agents into taking benefits of the situation for their own personal gains.
In this sense, it appears interesting to think  not about a libertarian utopia of a global decentralized economy but rather about an introduction of a touch of decentralization in certain financial areas thanks to  the blockchain technology in order to bring more transparency and new opportunities into the already existing financial scheme built during the last century or so.

But first what is DeFi ?

DeFi can be defined as an open financial ecosystem  where you can build various small financial tools and services in a decentralized manner thanks to the use of the decentralized ledger of the blockchain technology. It includes : 

• Digital assets
• Open Source Protocols
• Open source smart contracts
• Decentralized application (dApps) built on the blockchain on top of smart contracts

As such, DeFi offers with it’s open source nature a possibility for a true shock of transparency in the derivative market by breaking the knowledge asymmetry between investors and sellers by allowing potential investors to do their own audit of the product through reviewing the code in order to make educated investment choices.

Also, this open source philosophy allows each engineer of the ecosystem to become a possible auditor enabling as such the development of a faster security improvement dynamic as well as a better notation system of financial products given the vast diversity of auditors and the absence of possible lobbying or political pressure on notation agency.
Finally, since these applications are mostly built on the Ethereum blockchain, they can all be combined, modified and integrated according to investors fantasy without any barriers of entry. In other words, a single investor in Asia could totally use an existing smart contract to trade synthetic dollar and modify this latter to create a synthetic S&P 500 index and expose himself to the capital appreciation of the american stock market without needing any permission of any kind.

The DeFi ecosystem and its products

In order to understand and grasp a bit more the scale of the impact of this new burgeoning financial sector it appears interesting to dive a bit more into it and analyze briefly the current existing products available for investors across the web.

Open lending protocols :

As the name suggest these are digital money lending platforms built on a blockchain. Just like in a bank, users deposit their money and when someone else borrows the digital asset they earn interests. However, instead of intermediaries, here the smart contracts dictate the loan terms, connect lenders and borrowers, and are in charge of distributing the interest. In this sense, due to the inherent transparency of the blockchain and the absence of middleman, the lender earns higher returns and understands more clearly the risk that he is taking.

Stablecoins :

Unlike other crypto coins which have a volatile value, stablecoins are blockchain-issued tokens designed to hold on to a specific value. This is usually done by pegging it with fiat currencies like the US dollar, but often times with other assets like gold. Moreover, those coins, incorporate collateral to accommodate for price variations.

Decentralized exchanges and open marketplaces :

Unlike centralized exchange like Coinbase, decentralized exchanges have peer to peer transactions of digital assets between two parties on the blockchain with no third-parties involved. The advantages of this approach being the absence of withdrawal fees and the non-necessity of sign-ups, and identity verification for each users. 

Issuance and invest management platforms :

A significant portion of issuance platforms is currently honing in on the security token market. To do so, they developed standardized token contracts for securities such as the ST-20 and R-token enabling them to automate compliance and customize trade parameters in order to meet the regulatory requirements. Additionaly, they are also integrated with various service providers such as custodians, broker-dealers and legal entities to assist issuers.

The current limitation of DeFi

Even though the whole DeFi ecosystem is built on this concept of open source smart contract where the code is law, for now the DeFi ecosystem still remains quite centralized in its governance as prove the existence of master key detained by the funders of most major projects to ease upgrades and provide emergency shutoff valve in case of buggy code. However, as the code becomes more battle-tested, we should see a slide toward more decentralization with developers giving up these backdoor switches.

Moreover, due to the relative infancy of the sector, even though the auditing and security test of the different financial assets released on the market has come a long way since the big DAO hacked of June 2016, it is important to bear in mind that it is not a mature field and that new hacks or bugs can still happen. In this sense, potential investors must be aware that the better protection for their investment beyond a basic understanding of the technology still remain to play an active role in their own security by using double authentication process and keeping their holdings and keys secrets.

Conclusion

For now the DeFi market is still tiny in comparison to traditional finance, however it has picked up its pace rapidly since last year and by bringing money online it could very well create a big leap forward in what’s possible when it comes to the functionalities of money. In this sense, it will not be surprising if, in the near future, thanks to the development of new projects and financial dApps, we see the traditional finance market starting to interoperate heavily with the blockchain technology and its ecosystem in order to bring new and more transparent investment opportunities to investors.