The concept of blockchain was first proposed by Stuart Haber and Scott Stornetta in 1991. It wasn’t until 2008 that Nakamoto Satoshi conceptualized the first blockchain and created Bitcoin. Since then, countless projects have sprung up, hoping to revolutionize the blockchain space.

However, it was not until 2015 that a genius named Vitalik Buterin (V God) created Ethereum that he took a critical step in the change. Ethereum implements a Turing-complete language that allows programming on the blockchain (known as smart contracts), which opens us up to new possibilities.

Smart contracts allow projects and individuals to issue tokens and raise funds, ie ICOs and STOs. Raising funds through cryptocurrencies is the main reason why the market capitalization of the crypto market soared to $815 billion in 2018.

However, the cryptocurrency market has since lost 85% of its value as governments tightened regulations. The emergence of DeFi is the next key we must grasp, and it brings new hope to the blockchain field.

What is DeFi?

DeFi, short for decentralized finance, aims to recreate traditional banking services without centralized entities—savings, lending, trading, insurance, etc.

Its goal is to provide an open alternative to the world’s Internet-connected people.

However, it is more suitable to be called “distributed finance” or “open finance”, because most of the current DeFi products and services are a combination of centralization and decentralization.

DeFi – the second breakthrough in blockchain history

Bitcoin, as the first breakthrough of the widely recognized blockchain, combines a lot of knowledge of cryptography, consensus mechanism, peer-to-peer network and incentive mechanism.

Bitcoin has become a store of value that can be transferred without the involvement of a third party.

DeFi can be seen as a second breakthrough. Although it is not yet as disruptive as Bitcoin, DeFi has begun to take shape and has shown its potential.

Why is it said that DeFi is the second breakthrough?

To understand DeFi, one must first understand why it exists.

DeFi exists because it can satisfy some people’s financial needs that cannot be met by the traditional financial system.

The goal of DeFi is to establish a transparent financial system. The system is open to all, requires no permission, and does not rely on third-party institutions to meet financial needs. Such as loans, transactions, payments and various derivatives.

DeFi is open finance utilizing blockchain infrastructure. Using blockchain, people can verify every transaction made on it, which also brings transaction transparency.

DeFi is a special challenge

The creation of money is a spontaneous process, inevitable in the evolution of human beings. Initially, people exchanged items for items, forming a barter exchange. However, bartering is very inefficient because it is very difficult to find two people who happen to have matching items.

It is difficult to come to an agreement between a fisherman in need of shoes and a shoemaker in need of food. Even when the needs match, it can be difficult to determine how much fish to trade for a pair of shoes.

Hence, the demand for money arises. People need a currency system to exchange between different items. This currency becomes an intermediate medium of exchange that also has a store of value.

Throughout human history, there have been various currencies ranging from seashells, precious metals, gold, to what we know today as legal tender.

Then came intermediaries like commercial banks, investment banks, stockbrokers, pooled investment funds, and stock exchanges.

These intermediaries increase market efficiency and enable better resource allocation. But at the same time, the existence of intermediaries also causes problems such as opacity, which often leads to excessive debt or hyperinflation problems.

In the current financial structure dominated by financial intermediaries, economic crises seem inevitable and history keeps repeating itself.

The core value of the blockchain is transparency and distribution, and it is the best medium to change the status quo of the financial structure. This is why DeFi exists.

DeFi is similar to traditional finance

Like traditional finance, DeFi allows everyone to invest their funds in different assets according to their needs. Through various assets, contracts and agreements, new projects can be combined to provide users with new products and services. For example Compound.

Compound is an Ethereum-based lending marketplace. In Compound, users can borrow ETH, MakerDAO’s Dai, or USDC tokens, which are fully backed by U.S. dollars. Users can also exchange cDai tokens by lending tokens to Compound. cDai is equivalent to the user’s Dai and the resulting interest.

cDai itself is also a token, which means that cDai can be circulated in the market, and holders can also benefit from it. For example, users can trade cDai with ETH, hold cDai through Dex such as Uniswap, and earn interest on cDai tokens.

In addition, it can also be used in other smart contracts, such as MakerDAO mortgages ETH or BAT to generate Dai tokens, puts Dai into Compound to generate cDai, and then cDai can be exchanged with other tokens on Uniswap.

DeFi is a new world parallel to traditional finance

Traditional finance has earned the trust of many through intermediaries and their services. It can meet the needs of many people in the real world, but the service is the same for everyone.

However, some people want to take control of their finances. To serve these people, DeFi is building a world parallel to traditional finance.

For example, Compound, Dharma, Maker, etc. are all providing lending services for encrypted currency assets, which can be regarded as encrypted versions of traditional banks. Projects like Uniswap, Kyber, and Bancor offer asset swap services similar to Nasdaq, NYSE, and other exchanges in the traditional financial world.

DeFi is not just a world parallel to traditional finance

DeFi not only mimics traditional finance in the crypto world, but also offers new capabilities. It provides instant transaction services through the pool of funds, which may take 3 to 5 days to complete in traditional intermediaries. DeFi can also adjust the loan interest rate in real time without the traditional borrowing grace period.

The borrowing income of users is reflected by their tokens. If users purchase tokens, they can actually enjoy the borrowing income of tokens, which is equivalent to tokenizing creditor’s rights and realizing circulation.

DeFi has greatly accelerated the liquidity of assets. Its “permission-free” and “transparent” features are beyond the reach of traditional finance.

When participating in DeFi services, users interact with a series of smart contracts on the blockchain.

People can take advantage of its transparency and permission-free features, such as getting the best price transactions through DEX aggregation, and the best way is to aggregate interest income through loan agreements.

From a lending perspective, current borrowing demand requires overcollateralization to borrow. In DeFi, all lending and liquidation procedures are enforced through the agreement, so there is no need to worry about default, and no third-party intervention is required.

At the same time, lenders can earn higher incomes and borrowers can get better interest rates due to the omission of intermediaries.

The integration of DeFi and traditional finance

At present, not everyone has the ability and willingness to learn and manage encrypted assets. Therefore, the more likely scenario is the integration of DeFi and traditional finance.

Traditional finance can use the characteristics of DeFi to achieve liquidity, and DeFi can use the assets and compliance of traditional finance to achieve scale expansion.

USDC is an example of the combination of DeFi and traditional finance. USDC enters the currencies of the traditional world into DeFi to form a stable currency, and then uses the features of DeFi such as permission-free, fast circulation, and transparency to play a role.

Traditional financial needs have their historical inertia. From today’s point of view, without the participation of traditional finance, it is difficult for DeFi to expand. Although this is not what many idealists and geeks want to see, in the real world, DeFi can help traditional finance achieve faster asset flow through the blockchain.

DeFi is 100% decentralized finance

Anyone with crypto assets can participate in DeFi. These are usually done through operations on the chain, without third-party participation, and users have a lot of freedom to participate, which is convenient and fast.

However, any DeFi service has some degree of centralization. For example, Dai is not 100% decentralized. Its security requires governance of MKR token holders and protection against attacks on its oracles, all of which need to be centralized to maintain its security.

This will become more apparent as real-world assets circulate on DeFi. For example, if you bought 100% house tokens. Houses involve a lot of legal rights and obligations in the real world, so you can’t just transfer tokens to get all the rights automatically, these need to follow traditional laws and processes.

Prospects for DeFi

At present, through DeFi, people can realize loans, transactions, payments, futures and other functions, but for most ordinary users who have no experience in using encrypted wallets, there is a certain threshold. It requires users to have certain asset management capabilities and experience.

However, as more and more DeFi projects simplify their operation, it becomes more convenient to use. When people use DeFi products, the difficulty of using them will gradually decrease. Once the habit is formed, more and more people will enter the DeFi field.

Responsible editor: ct

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