Lesson 12: Understanding DeFi – financial services under the blockchain umbrella
Decentralized Finance (DeFi) is an instrument for expert investors that is changing the way financial transactions are done. Operated using blockchain technology, these financial services allow making loans, purchasing assets, taking out insurance, etc., always on a user’s own behalf and individual liability.
The DeFi movement promises to transfer traditional financial products and services to the world of blockchain technology, initially capable of working without centralized middlemen such as banks or government agencies, where the party that is ultimately liable is the user, whether an individual, the owner of a business, or a company.
DeFi is incipient financial technology that allows transfers of funds or loans through “financial contracts in blockchain support or form, therefore recorded in an immutable blockchain”, in the words of Javier W. Ibáñez, Doctor of Law and Director of the FinTech Legal Observatory. According to the World Economic Forum, DeFi aims to “reconstruct and reimage financial services”.
Operated with smart contracts, DeFi is automatic: DeFi services are executed autonomously, without the need for orders and middlemen once certain conditions are met. Blockchain technology seeks to provide security to and transparency in transactions.
Although the main purpose of this financial technology is the empowerment of users for managing their money and investments through digital wallets and services, DeFi can offer great opportunities for financial entities through reliable regulation.
It was announced at the end of July that the Bank of Italy (the Italian Republic’s central bank) is going to promote a test dubbed the “Institutional DeFi for Security Token Ecosystem Project”. Milano Hub, the central bank’s innovation center, has chosen Polygon for this initiative, which is a protocol for building and connecting Ethereum blockchain networks.
Up to now, decentralized finance has not been subject to specific crypto regulation, and it can be subject to jolts of instability that are particular to digital structures or be open to different types of fraud.
The future of finance
What new sectors will arise with DeFi, or what well-established sectors will be transformed by it?
- Peer-to-peer loans and credits. Just as it happens offline, or online without cryptography but adding this security layer, users will be able to lend funds between each other.
- Decentralized exchange (DEX) of assets. Private individuals will be able to buy and sell cryptocurrencies and other digital tokens to and from users and organizations, or directly in open markets.
- Savings mechanisms. Within DeFi, it will be possible to deposit funds in protocols that offer returns for participating in the network or for providing liquidity to markets, due to the decentralized way in which they operate.
- Insurance contracts. There will also be a market for insurers who provide protection against the risks associated with blockchain, from theft and hacking to technical errors.
- DeFi aggregation services. Within this ecosystem, the equivalent of a centralized banking panel can be developed so that users can view everything at a glance.
- Aggregation of opportunities. At the same time, these panels will allow the optimum construction of interfaces, portfolios, and the approval (also automatic) of new opportunities and markets.
In the future, there are proposals such as DeFi social networks for developers, early adopters, and companies, and even gamified processes for promoting these tools. The turning point for the massive adoption of these systems will come when the essential regulations arrive.