09:30 25.03.2021

DeFi a trend or future alternative?

5 min read

Blockchain technology was significantly developed when the Ethereum platform-book appeared. It became a revolutionary tool for improving safety of data storage.

Compared to the Bitcoin, the Ethereum provides more flexible and promisingly useful use of the technology. It became possible due to smart contracts which are written by software programmers when creating Decentralized Applications (Dapps). After their development - they are deployed into the Ethereum network, which maintains the digital value and keeps its track.

The above mentioned sophisticated invention can be used almost in any sphere where information plays a key role. Due to its self sufficiency and high level of safety - the technology makes any traditional data custodian (e.g. state authority, bank, notary, etc.) just a useless “middle-man” for individuals. Because there is no need to entrust information storage, check and approval to those archaic institutions anymore. It makes possible for people to perform high-risk operations (which are mostly related to a financial sector) directly between each other using only software, without a fear of being cheated by one another. 

However the logic of smart contracts is extremely simple and can be expressed as “if this, then that”. Such simplicity leaves no room for a trick, because it is guaranteed by computer code instead of a human. That is why impartial performance of smart contracts is absolutely safe from any human error, because the Etherium book cannot be corrupt or compromised.

As opposed to centralized data storage and decision making, Ethereum has opened the new way, which is decentralized because of its “spreading” between all users.

Let’s briefly stop on a few examples of how decentralized approach is changing the financial market sector.

Decentralized Autonomous Organizations (DAO)

A Decentralized Autonomous Organizations or DAO is a fully autonomous organization which is not governed by any single person but instead is governed through program code. This code is based on smart contracts and enables DAOs to replace the way that traditional organizations are typically run. There would be no chance to be affected by any outside influence. Managing decisions or rulings would be decided via DAO token voting by all tokens holders. Such a way makes decision making process absolutely transparent and fair to all “stakeholders”. 

Decentralized lending and borrowing

Nowadays the role of an intermediary between people who provide a loan and borrowers is taken up by banks and credit unions through the credit system. The borrowers must show their ability to repay the loan before borrowing. There are also geographical and legal restrictions in place, which automatically exclude large amount of potential borrowers. 

In the DeFi sector, banks are no longer necessary and such barriers do not exist. Anyone can contribute to a decentralized liquidity pool from which borrowers can take funds, and then pay back at an interest rate determined by an algorithm. Compared to the banking system, there are no Know-your-customer (KYC) and Anti-money laundering (AML) policies, it is only required to provide collateral to take a loan in DeFi.

Decentralized Exchanges (DEX)

The main difference between Centralized Exchange (CEX) and Decentralized Exchange (DEX) is that for CEXs, assets for the trade would be held on the exchange wallet whereas for DEXs, assets for trade can be held on users’ own wallets.

Decentralized Derivatives

Despite derivatives as a financial instrument which normally related to some classical financial market subjects as: stock, currencies, indexes of products, there was found the way for projection of those on Ethereum-based protocol for Synthetic Assets - called Synths.

E.g. Synthetic Gold (sXAU) is a Synthetic Asset that tracks the price performance of real gold.

Synths can be traded without the need for traders to actually hold the underlying asset. Compared to traditional gold brokerages, Synthetic Gold (sXAU) allows traders to participate in the market much easier. Synths have another useful utility - as they can be traded between one another, meaning Synthetic Gold can be switched for Synthetic JPY, Synthetic Silver or Synthetic Bitcoin.

There are also some other financial instruments appeared in decentralized environment: Decentralized Fund Management, Decentralized Lottery, Decentralized Payments, Decentralized Insurance.

The main difference of all DeFi services is their accessibility. They can be used by anyone, anywhere in the world who has a mobile phone and internet.

Questioning the legal aspect of DeFi, a specialist in the field of IT law, Senior Partner of the law firm  “Legal Welt”  - Sergey Malomuzh notes that: “At the moment no law regulation can stop or control users of accessing DeFi, because the whole Ethereum blockchain is accessible worldwide by anyone. Even though the project teams had control of the frontend of their website services, they had no control over who can or cannot access the backend (protocol) deployed onto the Ethereum blockchain. So even platform runners cannot restrict specific groups of people from DeFi, what creates some risks but at the same time brings equality to everyone using it.”