We’ve talked about a lot of heavy hitting subjects recently. Every once in a while, it’s good to get back to the fundamentals. The latest advancements of Defi (Decentralized Finance) is a common topic here so let’s talk about it from a different perspective.
What is Centralized Finance?
The banks, the stock market, the federal reserve, you name it. All those big entities that manage money/assets. Every single one of them is centralized, because that was all that had been invented up until 2009 when the Bitcoin whitepaper was written.
What’s Wrong With Centralized Finance?
Control over the flow of money is unfairly concentrated in the hands of a small number of people, and not the ones most affected by the flow of money. The people who work a 9-5 don’t get a voice in these big entities besides their vote for a politician, who could vote to pass new legislation, but usually have their own agenda. The rich buy politicians.
Stuff like inflation and increasing the money supply disproportionately impact the poorest people. The poor will afford less on the same paycheck. The rich continue getting richer, unimpacted by inflation, because they can afford to invest their wealth
When it’s all you know, you may not realize how powerless you really are. Not everyone can get a bank account, there are rules. You need a government issued SSN, you need to be a certain age, you need an address to recieve your documents, etc. You are not in control of your money. Banks can, to some extent, tell you what you can and can’t do with your own money.
Rules aren’t always bad of course, but people are beginning to see that the rules are not equal. The recent Gamestop short squeeze is a prime example of market manipulation and the unfair playing field. Individual investors fought for their rights to buy the the stock and take profits from the hedge funds.
What is Defi (Decentralized Finance)
Defi describes financial services built on top of blockchain technology. It has much of the same services as centralized finance. Money is stored, printed, and exchanged in an automated fashion, such that no entity has significant control (therefore, decentralized).
Unlike centralized finance, anyone with an internet connection can participate. That includes children, the homeless, foreign citizens, the poor, the rich, whistle blowers, freedom fighters and felons. The technology ensures rules are clear and apply to everyone equally. Every single transaction is public and viewable by everyone in the world forever (currently).
Whales are a fact of life, and some will accumulate vasts amounts of cryptocurrency wealth. While the whales of centralized finance can buy politicians and therefore power, we can reasonably expect cryptocurrency to remain fair. The community as a whole needs to agree to change the blockchain in near unison or the currency splits to accomodate the differing opinions (fork).
Beyond that, a smart but poor person can sometimes play games like a whale. Flash loans are a Defi only utility in which you can borrow as much money as you like for a very very short period of time in an atomic nature.
I’ve written an article on this before, but it allows you to leverage huge amounts of money like a whale would. In what is a few seconds for us, the blockchain sees as instantaneous. If you can borrow money and repay it back instantaneously (in the eyes of the blockchain), that is acceptable and risk free. What you do inside those few seconds is up to you. You could somehow use it in the markets to double the money you borrowed, in which case you repay the loan and profit “instantaneously”. You could lose money in the marketplace to where you can not repay the loan, in which case it never happened in the first place “instantaneously”.
The Problem With Defi
As it is now, Defi is difficult. It’s unweildly, it can randomly be much more expensive than you’d expect and it can be slow. It’s probably bad for the enviornment. Interest rates are really good, but there’s also a ton of scams going on.
None of these are inherit problems with Defi itself. Scaling technologies are already being built to address fees (gas prices) and transaction speeds. We are investigating different methods of consensus to curb the enviornmental impact (Proof of Stake being the current favorite). We are also rallying around trusted services and emphasizing the risks of scams.
By now, we are used to and unreasonably comfortable with the drawbacks of centralized finance. It may be hard to believe, but it can and should be better. Decentralized finance isn’t perfect and it isn’t going to completely replace the current system. The fact that there is an alternative to centralized finance is revolutionary itself. It exists and it functions. The fact that people can opt out of the current system may be what it takes to motivate the ones in charge to build something more fair.