Finance and financial resources have long been controlled by centralized intermediaries, but decentralized finance can be the key to changing that dynamic.
For almost as long as the idea of finance has existed, the access and control over financial information has been dominated by financial intermediaries. This arrangement has created benefits for everyone involved. Ease of access to financial resources and information is one benefit, but another benefit for consumers and customers is the offloading of risk onto these third party intermediaries.
Put simply, the underlying trade-off for consumers and businesses has been the convenience of access to financial resources, offset by relinquishing control and authorization to third party intermediaries.
Although this arrangement is familiar, and has become part of the modern financial system, there are multiple flaws that continue to come to come to the surface. Centralizing control spawned the reality of being too-big-to-fail, concentrated risk in a relatively small number of institutions, and led to some socioeconomic groups being chronically under banked.
Blockchain was lauded as the technology that would change all of that. It still just might, but until recently the “killer app” to actually democratize access to financial resources and information was missing. Enter decentralized finance, or DeFi, which by all accounts seems to be the missing application that will finally allow blockchain and the cryptoasset space to generate the savings, efficiency, and transparency that have been long promised.
That said, it can be hard for CPA’s and other financial professionals to understand just what DeFi is, what it means, and what clients need to be made aware of.
Especially with all of the market coverage of DeFi applications (and scandals), this topic can be confusing even for the most well informed blockchain aficionado. Such a busy and fast moving landscape, however, is also an opportunity for practitioners and organizations to stand out. Let’s take a look at a few of the core considerations and factors every financial professional and organization need to know about DeFi.
Smart contracts and dapps. A blockchain, in and of itself, is just a ledger or record of previous transactions, and in order for blockchains to interact with other technology systems there needs to be some sort of connecting application. Smart contracts serve as the connective tissue that allows blockchains to communicate with other blockchains, other users, and legacy technology systems. Smart contracts are the secret sauce that power many blockchain applications, and DeFi is no exception to this rule.
Building on this, the creation of entirely decentralized applications (dapps) allows entire organizations to operate with minimal human oversight, and without a centralized authority. In terms of DeFi, this will enable loans to be screened, approved/denied, and managed with limited interference or oversight by the very same centralized incumbents blockchain was intended to disintermediate.
Public blockchains back to the forefront. Over the last several years there has been a pivot and shift in terms of blockchain development from a focus on permissionless blockchains – highlighted by the bitcoin blockchain – to more permissioned or private iterations. While it is true that there certainly are permissioned blockchain players and options in the DeFi area, public blockchains are playing a prominent role.
This might seem paradoxical, but by using a public or permissionless blockchain the underlying code – and applications such as DeFi running on top of the code – are actually more secure than might otherwise be expected. By, basically, exposing the blockchain, blockchain applications, and the underlying code of these different tools, the entire community and user base have the opportunity to edit, improve, and strengthen the applications from the ground up.
Frictionless finance. Blockchain was initially developed with the idea to reduce friction, minimize fees associated with financial transactions, but that expectation and promise ran into some stumbling blocks. Specifically, a large component of the financial infrastructure that underpins many blockchain use cases has come to resemble the incumbent organizations blockchain was designed to disrupt.
Centralized crypto exchanges, private forms of money (stablecoins) issued by a singular entity or association, and a number of walled-garden-like blockchain projects have emerged as blockchain ideals confront market realities.
DeFi projects, building on the utilization of smart contracts, dapps, and public/permissionless blockchains, are allowing many of the benefits of blockchain technology to be realized. Increased transparency, lower fees, faster settlement of transactions and trades, and no centralized entity with outsized influence over the process are all possible alongside the maturation of DeFi.
The blockchain ecosystem is a unique combination of technology, financial services, and a desire to improve the access and transparency associated with information. Many different blockchain applications and use cases have emerged across industry lines and economic sectors, but the DeFi movement stands apart.
Due to the very nature of how DeFi operates and functions, this step in blockchain development might a key piece in accelerating wider utilization and understanding of the technology itself.