What Is DeFi?

What Is DeFi on Ethereum

Decentralised finance (DeFi)—or open finance—is a term used to describe a suite of crypto projects that are decentralising financial services. To build DeFi projects, developers make use of technologies such as blockchain and smart contract.

Why DeFi?

At present, the financial services industry relies on institutions and banks to serve as a trust layer. With the help of law enforcement, these trusted intermediaries keep the financial system running. To make it worth their while, we pay them fees.

With DeFi, there’s no need to trust a middleman. Their role is unnecessary thanks to a blend of cryptography, smart contracts, and blockchain. Compared to the current financial services industry, DeFi promises to be more accessible, interoperable, and efficient.

DeFi Use Cases

In DeFi, the number of trustless protocols and decentralised applications (dApps) is increasing at a healthy rate. The majority of these are built on the Ethereum blockchain. This is mainly due to Ethereum’s strong developer community, advanced smart contract scripting, and supporting infrastructure (e.g., wallets, exchanges, developer tooling).

Below are some of the most promising DeFi sectors and use cases to date.

  • Lending and borrowing
  • Stablecoins
  • Decentralised exchanges (DEXes)
  • Derivatives
  • Insurance

Lending and borrowing is arguably the most active component of the DeFi ecosystem. Examples of DeFi lending and borrowing solutions include Compound and Maker. You can earn interest on Ethereum DeFi lending platforms by depositing cryptocurrency. More in the below Nugget’s News YouTube video.

DeFi Risks

It’s important to note that DeFi is new and experimental. It’s true that decentralised finance is trustless in the sense that there’s no middleman. However, at this early stage, there are still some areas of risk you need to accept.

Smart contract risk 

Developers have only been writing and implementing smart contracts on blockchains networks for a handful of years. When you’re dealing with financial services, that’s nowhere near enough time. Smart contract errors and bugs are likely to continue in DeFi.

There are a number of ways smart contract risk can be mitigated. For example, reputable security firms can perform code audits and formal verification.

Centralisation risk

At this early stage, the term ‘DeFi’ is misleading. For a DeFi project to exist, it needs to be built by developers—which control admin keys. Developers can use admin keys to change different parameters of the smart contract systems that underpin their DeFi project.

Developers’ ability to adjust these smart contract parameters can result in financial loss to users. This is one of the biggest centralisation risks. Fortunately, ways to mitigate risks involving admin keys are improving.

Oracle centralisation is another component of DeFi centralisation risk. DeFi smart contract systems rely on oracles for pricing information. Depending on the oracle system, there are risks concerning the ease with which this pricing information can be manipulated.

Ethereum DeFi Interviews by Nugget’s News

Learn more about DeFi by watching or listening to the below interviews by Nugget’s News founder Alex Saunders. Clicking the guest’s name will take you to their YouTube interview. If you’d prefer to listen, please click ‘Audio’.

Guests in these interviews belong to teams that are building much-needed solutions for open finance on Ethereum. Projects include Maker, Nexus Mutual, Kyber, DeFiZap, and Synthetix.

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