Decentralised Finance (DeFi) is an alternative financial system that aims to be more decentralised and transparent than traditional finance. First appearing a few years ago, DeFi is built on a public blockchain, like Ethereum, and relies on smart contracts, programmes that are automatically executed on the blockchain if pre-established conditions are met. In this tutorial, we'll explain the basic concepts behind DeFi and give you an overview of its benefits and challenges.
Key concepts Here are some key concepts to understand to get a better grasp of DeFi:
👉 Blockchain: a digital database that serves as a decentralised guestbook to record financial transactions. DeFi uses this technology.
👉 Stablecoins: tokens whose value is indexed, most of the time, to fiat currencies such as the dollar or euro. Stablecoins seek to maintain a constant value of a crypto asset compared to a traditional asset.
👉 Smart contracts: programs automatically executed on a blockchain if pre-established conditions are met.
👉 DAO (decentralized autonomous organization): a governance structure with no central authority. Members hold a governance token that allows them to exercise voting rights as a stakeholder in the community. They are the spearhead of DeFi.
👉 Exchange platforms: online platforms for exchanging fiat money for cryptocurrency or cryptos between each other. In DeFi, we talk about DEXs (decentralised exchange platforms), which are peer-to-peer marketplaces without a market operator.
DeFi vs traditional finance Traditional finance is based on a centralised system with numerous intermediaries (banks) and central authorities (central banks). In the current financial system, all money management goes through financial intermediaries, in particular banks. DeFi seeks to give power back to users over the management of their money and, more generally, everything they own.
DeFi is built on a public blockchain, which means it is decentralised and open to all. Smart contracts make it possible to create financial products and services with a view to developing an open financial system. To achieve this goal, DeFi seeks to disintermediate the world of traditional finance. DeFi applications do not need banks or brokers, all transactions are automated through the use of these smart contracts.
The benefits of DeFi DeFi offers interesting opportunities by challenging part of traditional finance and allowing easy access to financial services for those with an internet connection. DeFi allows users to free themselves from financial intermediaries who collect fees on each transaction, because it is the users themselves who collect them, and these fees are relatively low.
DeFi is also attractive for the empowerment of users, who can give their opinion on the community policy to be adopted thanks to the holding of governance tokens. One of the things that sets DeFi apart is the use of cryptocurrencies, which allow users to retain permanent ownership of their funds, even if they are used in a service. In other words, no third party can get hold of their funds without their permission.
DeFi protocols are developed as open source, which means that developers from all over the world can improve the financial products and services on offer.
The challenges of DeFi DeFi faces several challenges. The first is the high cost of transaction fees on Ethereum, which can increase significantly in the event of network congestion. Developers are currently working to solve this problem by developing overlays for the Ethereum blockchain, known as layer 2, to improve scalability while maintaining a secure, instantaneous and low-cost network.
Another major challenge is security, with an industry that has already seen numerous hacks resulting in the loss of hundreds of millions of dollars. Vulnerabilities in some smart contracts allow hackers to divert large amounts of cash, damaging the image of decentralised finance. Unfortunately, this has also led to a reluctance on the part of banks to embrace DeFi, which is one of the biggest obstacles to its development.
Finally, education is a major challenge for DeFi. Although some of its services are innovative, it is essential that citizens are enlightened and acculturated to this new form of finance. As DeFi protocols are evolving, it is necessary to learn to understand how they work to optimise their use.
Conclusion DeFi is an alternative solution to traditional finance that seeks to hand power back to users by developing an open, transparent and decentralised financial system. DeFi offers interesting opportunities by providing easy access to financial services for those with an Internet connection. However, DeFi faces major challenges, particularly in terms of cost, security and education. Despite these challenges, the future of DeFi promises to be exciting and innovative.
