Are DeFi a financial revolution?

DeFi is short for Decentralized Finance or "decentralized finance." This term encompasses a series of financial applications based on blockchain technology. Its growth has been exponential since April 2020. At the moment, some 40 billion dollars are locked in DeFi protocols, which represents a growth of 40% from a year ago, when these platforms had around 1 billion dollars. 

If an area has a centralized monopoly, it is financial. DeFi, on the contrary, implies a complete decentralization of each and every process, including governance. DeFi, by relying on a blockchain and being organized in a decentralized way, differ from traditional financial systems. They can control all aspects of transactions, organization, and even have privileged powers such as creating electronic money with a low-collateral loan system.

Another characteristic of these new financial services is transparency. When operating in a blockchain, generally from Ethereum, these processes in DeFi are transparent. Anyone can follow, for example, movements between portfolios using applications like etherscan. That is, cheating becomes more complicated, precisely because of the use of a technology criticized for allegedly serving indecent or illegal purposes.

A true revolution in DeFi is the much higher returns on investment than in traditional finance. The reason is none other than the fact that part of the profit generated by the protocol is reinvested in the protocol itself. For this reason, the small pieces of governance (known as Tokens governance) grow in value. The token, therefore, increases in value, which leaves in the position of the holder of the token owning it, and not selling it, which also increases its value. It is an incentive system that was already born with Bitcoin (game theory). This way of approaching a business is revolutionary, because the success of a project as a DeFi protocol benefits all its users who have a token (and not just shareholders, as in the traditional market). Clearly, the incentive is to create products for users in order to increase the total value of the protocol. The TokensTherefore, they are a hybrid of virtual currency, company shares, and even store of value (the clearest case is bitcoin).

On the other hand, when these protocols are organized around decentralized entities, a prior identification is generally not necessary, that is, they do not require permission for their use. They are, therefore, offering for the first time basic financial access that cannot be censored. Just as Bitcoin cannot.

Among the most popular DeFi applications we can mention the following:

Decentralized Exchanges (DEX): sound exchanges decentralized through which users connect directly so that they can exchange cryptocurrencies with each other, without entrusting their money to an intermediary. This is done with liquidity pools provided by the users themselves, so that it does not work through the traditional order book system. There is always the option of making an exchange, and the price will be determined by the specific demand for a pool, is what is called "stressing a pool”. This has been the great contribution of Uniswap, later copied by others, such as Sushiswap. Personally, our law firm has recently participated in the first Spanish-speaking DeFi, launched from Spain under the name of Bamboo DeFi, and which began trading on February 2 in the exchange MEXC.

Stablecoins: They are cryptocurrencies that are linked to an asset outside of it (the dollar or the euro, for example) to stabilize the price. The case that best explains this protocol is Maker, which owns 16% of the DeFi market. The idea of ​​this protocol is to create a stable currency with the value of the dollar called DAI. To generate DAI, the Ethereum currency (ether) must be deposited as collateral. The funny thing is that, despite leaving collateral, the community uses DAI, generating a stable and decentralized currency. The token governance of the protocol is MKR.

Loan platforms: These platforms use smart contracts to replace the intermediaries (such as banks) that manage the loans in the middle. As in the DEX, it is the users who provide liquidity to be able to constitute the loans. We can cite COMPOUND as an example.

"Wrapped" Bitcoins (WBTC): One of the characteristics of the Bitcoin network is that it is different from that of Ethereum, where - at least until now - practically all the DeFi are developed. Therefore, to exchange Bitcoin on these platforms, you would first have to sell the Bitcoin or exchange it for ETH. In the case of sending Bitcoin for example to an Ethereum wallet or wallet, it means losing the Bitcoin. That is why this "new token”Generates the so-called WBTC (compatible with ETH) once Bitcoin is left as collateral. A very appropriate idea and hence its enormous success. A clear advantage is that while bitcoin does not generate profit on its own (unless it rises in value), WBTC users can benefit by earning Tokens for lending through the decentralized lending platforms described above. A great idea.

betting: markets to bet on the outcome of future events, such as elections. The goal of the DeFi versions of the prediction markets is to offer the same functionality, but without intermediaries. The best example of this type of protocol is Augur, which was born in 2014.

In addition, there are insurance protocols (Nexus mutual) or investment funds (Melon).

Finally, DeFi platforms have provided two new concepts of return on investment. First of all, the so-called liquidity mining. Its objective is none other than to reward those who deposit their Tokens on the platform, and in return deliver the token own protocol. If this has value, it can be a fairly high return. Started first idex, and later synthetix it adopted the same strategy, gaining a lot of market, then numerous protocols followed.

Secondly, yield farming, through which users develop various strategies between the protocols to obtain the highest yields. A special protocol that seeks the best profitability of the various protocols through smart contracts is Yearn Finance, created in mid-2020 by Andre Cronje, and which came to be worth every token more than Bitcoin itself.

The DeFi are a true revolution, and it seems to me only the beginning of what remains to be seen.

*The opinions expressed in this article are those of the author and do not necessarily reflect the views of the administrators of The Crypto Legal blog or the Lawgic Tec association.

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Ignacio Ferrer-Bonsoms
Degree in Law from the University of Navarra (2002). Lawyer at Ferrer-Bonsoms & Sanjurjo, based in Spain. Specialized in Blockchain, cryptocurrencies, digital contracts and international law. Collaborator with various digital media.


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