Defi (decentralized finance) can recreate traditional financial instruments in a decentralized architecture, outside of companies’ and governments’ control.
There is a reason for such financial instruments to exist in the real world. Hence, recreating it on with a decentralized structure makes it more attractive. It is like serving an already existing clientele but with more features. Traditionally, these needs are fulfilled by big financial institutions, but a lot of trust goes into them especially when we hand over our assets to be managed. But in a blockchain based Defi structure, everything in the contract is coded and made public essentially removing the trust factor, thereby making such instruments more attractive especially against scams.
Is Defi new?
It can be argued that Defi is not new. In fact, Bitcoin, the first cryptocurrency, is not actually a currency for many but a form of a store of value like gold. Many people, especially in countries like Cyprus and Venezuela, are using Bitcoin as a store of value even after the price crash experienced by cryptocurrencies. This is because of the fact that their local currencies are losing value even faster. Then came in Ethereum which made the world of crypto a lot more interesting. It let developers add self-executing code in the blockchain. This created what is called a smart contract. ICOs was made possible due to this. ICOs are like IPOs where new companies and projects raised funds to run their operations. Even though Ethereum gave the possibility of doing every conceivable project to run on its network, it still had many short fallings and this gave rise to many more Defi.
Even though one could create any kind of coin with Ethereum, cryptocurrencies have an inherent problem, volatility. This is important to many as they would like to see some security to their investment, the prospect that one fine day all their Bitcoin will be worth nothing is keeping many away from crypto. That is when stablecoins entered the market. Unlike Bitcoin or Ethereum, these coins have their value fixed at some rate. Dai is one such stable coin with its value is pegged at one dollar, then there is Compound and Dharma each which acts as a financial instrument on its own.
Dai’s value is based on assets, hard currency and unlike Tether, it is a decentralized stable coin on the Ethereum blockchain. Dai gives confidence to its user by using both decentralization as well as asset backing. This means that its purchasing power won’t get reduced over time. To make it a trustless platform, Dai has opted for full transparency as anyone can view the information about the locked collateral backing each Dai, including its safety profile. In the unlikely case of a black swan event, the system designed to employ Emergency Shutdown as a last resort to guarantee the stable price. Unlike Tether which stores one dollar for each coin, Dai is storing varied assets. Even though it is less volatile than most crypto if the value of underlying assets experiences volatility, Dai could change its valuation too.
Compound is a protocol which acts similar to a bank. It lets users earn interest on their investments. And it also has the facility to borrow directly from the protocol without the need for a counterparty or peer. It aims to be the fastest borrowing platform in the world soon, and it seems it is right on course. Recently, there has been a spike in transactions in the compound network which suggest an increased interest in the service and protocol.
Dharma aims to replicate fintech completely and unlike banks, users do not deposit their assets in Dharma’s wallet. According to the official website, the platform has already lent out $7.8 million with the capacity to increase that lending to $10 million. One can say looking at how they operate that it is a peer to peer lending platform. One of the two potential drawbacks is that it only gives users around 25 points in interest in a year and the second being that as of now, the platform only offers service in Ethereum and Dai.
With the advent of crypto, the possibilities in fintech have grown exponentially as it reduces the friction and eliminated the limitations experienced by traditional financial instruments. And now it seems that the promise of crypto is finally coming alive, what the future holds for this industry is surely exciting. But one has to keep in mind there are reasons why these controls and regulations exist, it is to prevent crime and fraud. It is not a call for more government control but if the community fails to self-police itself, governments will be forced to step in.
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