What is DeFi

Updated: Nov 12

By now you'd likely have either read about or heard of DeFi but it's still quite new to many or not even in their lingo. That needs to change especially as we're seeing so much movement happening in the space where new ways of doing business and earning money are happening. The world saw the bitcoin craze seem to come and go and come back again more recently in late 2021. We also saw NFT's (non-fungible tokens) sweep the world recently with things like NBA Top Shot and various sorts of stories of large amounts of money being made on what seem like just images/JPEGs etc.


Behind all of that, there is a system all of that and it starts with understanding a couple of things like, what are smart contracts (with a little help from the awesome DeFi educational website Finematics).


A smart contract is effectively a piece of code that can be executed automatically in a deterministic way (e.g. it cannot do anything apart from what is in the contract. It is not just a contract but can store, receive and send funds and all of this is to remove the human factor from decision making (the most error prone of traditional contracts).


This video from Finematics explains it further and even uses a vending machine analogy to look at this.



There's more nuances in there such as the need for oracle services that are established to provide trust in terms of what data is brought into a blockchain.


The video also goes through the need to use a coding language called Solidity and how all these contracts are immutable (can't be changed once deployed) and decentralised (no single machine controlling the contracts).


Ethereum is often noted as the main smart contract type platform but Cardano, Tron and others are also in this space.


In the traditional world of contracts, there are things like escrow and the reputation and counterparty risk that are affected by real world laws and human decision making. In situations like this, smart contracts are a better way to do things as they don't rely on any of the above issues as there is automation and nothing outside of the contract would work.


There is also benefits around lowered cost, easier reusability, lowered fraud and other areas that are tackled thanks to smart contracts.


DeFI

Smart contracts are at the very heart of Decentralised Finance (or DeFi) and has allowed various sorts of decentralised organisations to pop up (called DAOs) to solve a variety of financial services/markets problems.


There are various protocols out there in the world of DeFi that can be created thanks to smart contracts ranging from decentralised stable coins, automated liquidity provisioning, supply chain finance and others.


More of these kinds of new protocols are being created and it shows how traditional world finance can be moved ot this new world of DeFi.


Risks

This is not all without risk here as the whole world of DeFi and smart contracts is prone to what plagues other software such as software bugs. This can and has happened and has led to issues with money being lost and rules needing to be changed. It's also prone to hacking and we've heard many a story of this sort of thing whether coming from the inside or external to the industry.


Whilst all this kind of risk is there, it's improving how the DeFi market operates and the space is continuing to evolve to plug those gaps and fix any issues that come up. The future is going to see a lot more traditional ways of doing business start to chagne and it's a very interesting space we are in right now that's for sure.

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