How Crypto & DeFi is Revolutionizing Finance
Over the past decade, and this year especially, we have witnessed the rise of cryptocurrency and the many exciting technologies that are attached to it. As cryptocurrency starts to become mainstream, we’re taking a look at the world of crypto and answering one very big question – “will crypto revolutionize finance?”
It’s easy to see why this question is being asked. With the blockchain allowing for decentralized finance and cryptographically secured trades, it can provide both security and anonymity to many financial interactions. Then, with the possible integration of NFT technology into many areas of our life, the technology that crypto has introduced can change more than just your spending habits.
It may look like a lot but we’ve kept things simple and easy to understand, for beginners who will be new to some of the terminology used. We have also used links to supporting materials, as references to some of our claims and also for further reading for those who want to develop a deep understanding of Decentralized Finance.
Keep in mind none of the below is investment advice, but rather just meant to be an introduction to the changing financial space we live in today and help you come to understand the emerging field of decentralized finance.
You should likely supplement the below information with more educational resources on decentralized finance before going around talking about it with everyone you meet, as this is just a surface-level view and each of the aspects we cover in this article have their own rabbit-holes that demand hundreds of hours of research to really begin to comprehend.
Anyhow lets get into the content — now that you know what to expect from the rest of this guide, let’s start at the very beginning.
What Is Crypto & Decentralized Finance?
We need to discuss some of the terms we’ll be throwing around before we get into specifics. Let’s start with the finance sector that you’re probably familiar with. In many crypto communities, who see decentralized finance as the future, they call the standard financial world “legacy finance.”
Legacy finance is used to describe the current system of banks, brokerages, and non-crypto currency that we currently exist in. In our day-to-day lives, we don’t use crypto for the exchange of goods and services, and we keep our money on the books of large banking societies and brokerages where it is stored and/or invested.
Newcomers to cryptocurrency may find themselves asking – “why is crypto taken seriously if it’s not real money?” To that, many would ask what makes our money real in the first place. We use fiat currency, which means it is backed by the government and other financial authorities instead of the gold standard, or any other physical resource. This opens our currency to devaluation, inflation, and speculative bubbles, three things that we have seen come and go over the past few decades.
This unpinning from the physical world, and increased digitization of legacy finance, has set the groundwork for cryptocurrency to be taken seriously by big and small investors alike. If your crypto was stored on a bank card that you swiped at the store, could you appreciate the differences between them?
The optimistic goal of some of the earliest cryptos, like Bitcoin, was to become a currency of its own. Having said that, you need to keep two things in mind. One, way too many people spent billions in Bitcoin to buy pizzas over the last decade. Two, as it stands right now, crypto is treated more as an investment to be converted into USD, and so it’s still tied to legacy finance institutions.
Centralized Crypto Finance
While the idea of decentralization is popular in cryptocurrency communities, it’s not guaranteed when you’re using crypto — there is such a thing as centralized crypto finance, which aims to capitalize on the benefits of crypto without engaging in the riskier experimental world of decentralized finance.
In this context, you should see the word centralization as meaning “using a third-party/middleman.” Above we mentioned how many cryptocurrencies are treated like stock investments, where you throw money in and take money out once you’ve gained, and that’s facilitated by crypto exchanges like Coinbase and Voyager.
That is centralized crypto finance. It combines elements of decentralized finance with a more traditional, brokerage-style approach to trading cryptocurrency for profit. All action runs through the exchange, who take their cut, instead of exchanging crypto between individuals.
Another form of centralised crypto-finance is lending platforms such as Nexo and BlockFi or Hodlnaut who act as custodians to your cryptocurrency assets while lending them out, generally either to decentralized finance protocals or traditional financial institutional clients, earning you a good yeild on your deposits.
Decentralized Crypto Finance
Having mentioned decentralization several times already, it’s about time we explain what decentralized crypto finance is. Commonly abbreviated to DeFi, decentralized finance is an umbrella term that is typically applied to wherever blockchain technology is being used.
What is blockchain, you ask? In its simplest form, it is a digital ledger that tracks and records trades and other interactions within a financial network, where they cannot be edited after the fact. The ledger can be distributed between many different people, safeguarding the financial information from a central authority who would seize control and bend it to their own ends.
Blockchains aren’t inherently decentralized but, if distributed across enough people, it practically becomes decentralized. You can’t get thousands of people to fully agree on anything, let alone complex financial decisions, and so the decentralized status quo of blockchain is safer when more people participate in it.
The largest blockchain is Ethereum, hence why their proprietary crypto Ether is considered the silver of cryptocurrency, second only to Bitcoin in value. Blockchains, and decentralized finance as a whole, only work because of smart contracts. Where you’d traditionally need a bank to facilitate interaction and keep all parties honest, smart contracts automatically fulfill the transaction without allowing anybody the opportunity to welch on the deal.
With all middlemen removed and peer-to-peer trading guaranteed by smart contracts on a distributed, incorruptible blockchain – you get decentralized finance.
The Benefits Of DeFi?
If you haven’t already noticed, it’s the DeFi aspect of cryptocurrency that may revolutionize finance. While centralized crypto finance still makes use of legacy financial infrastructure, decentralized finance makes banks and other financial authorities, including world governments, nearly obsolete.
There are four major benefits associated with decentralized finance, all of which fly in the face of legacy finance institutions.
First, properly distributed blockchains are very transparent. That isn’t something you get with the legacy financial system, which is apocryphal at best to many people, and most institutions don’t disclose the algorithms and technology they use for processing financial transactions.
If you’re lucky, you may get a peek into your bank’s processes through KYC procedures that are required to verify blocked spending attempts. While inconvenient, at least you know they’re working behind the scenes to keep you safe from fraud, but you still don’t know the details.
However, a non-transparent financial system also opens it up to manipulation by those few who have access to it. It also reduces accountability for bad actors in those systems.
With the stock market, retail traders have a lot less information to work with than Wall Street when planning investments. This is just natural with centralization, the people at the center will have more access to information and resources, but that can change with decentralized finance.
DeFi systems make use of open-source code that allows users to see the code. This means that everybody can view the code and verify its authenticity. Will everybody do that? Of course not, but the right people will and can sound the alarm if something is off. Once a transaction is made and stored on the blockchain, it is visible to everybody without exposing any identities.
While being transparent, decentralized blockchains are also very secure because there aren’t any names attached. While transactions are visible, the senders and receivers are given encrypted IDs and wallet addresses. Unless specifically announcing online what your crypto wallet address is, nobody has any way of knowing who the person behind the transaction is. This simultaneously guarantees transparency and anonymity, which have been hard to combine in the past.
Of course, that’s assuming the blockchain is purely decentralized. As we covered above, larger, more distributed blockchains are much better for security. Blockchain tech also helps keep your data safe. In a world where nearly every company profits from our data, we can’t use services without signing away our information. That information can and does end up in the hands of third parties who can sell it to predatory businesses. Also, those companies and services are subject to data breaches.
With decentralized architecture, finance systems can be protected against hacks. General data gathering is limited because distributed blockchains are spread between multiple users. That means you need to hack them all if you want to get at the data, to the point where it wouldn’t be worth the effort.
Since it’s an emerging field, the leaders in DeFi are also very knowledgeable and accomplished. They aren’t entrepreneurs using common tech to build a business, they are professionals who are building whole new tech and show genuine interest in the software they make. The good projects obsessively find bugs and vulnerabilities in their systems and even pay white-hat hackers to do so.
That doesn’t mean decentralized finance is totally safe, however. Fraudsters can still profit off of good, old-fashioned social engineering and the mistakes of users, which is why being knowledgeable about the blockchain and how to engage with it is important. If you’re here, you’re already interested in doing just that.
Lower Overhead & Operational Costs
One of the main goals of blockchain technology is to reduce the cost of transactions between its users. The cost of engaging with a financial system is important to the everyday investor who wants to trade without suffering from overbearing operational and transactional costs.
Both centralized and decentralized crypto exchanges enjoy lower transaction fees because smart contracts take care of the busy work. Gas fees for the Ethereum blockchain were the main operational cost of trading many cryptocurrencies but now many projects are working with Layer 2 ZK-rollups. These will eliminate gas fees and allow for the scaling of blockchain systems, which is necessary if decentralized finance is going to overtake or integrate with our current systems in a finance revolution.
The added transaction costs for international transfers are also eliminated. By using DeFi, we can leapfrog over the physical and legal realities of international money transfers. They’re also executed instantly, so you don’t need to wait for anybody to authorize the transaction.
Undeniable Accountability (Smart Contracts)
Smart contracts are the backbone of the blockchain and DeFi as a whole. That’s why we should go into more detail about what smart contracts are and what they do.
A smart contract is self-executing, so it automatically fulfills each party’s liabilities when they agree to it. Those liabilities are detailed in the terms of the agreement, which are written into the lines of code that control the contract. This means every smart contract is tailored to the agreement you’re arranging, then that agreement is carried out quickly and conveniently. Once executed, they are stored on a blockchain and can’t be reversed, so you or the person on the other end of the deal can’t mess with the agreement.
This means you don’t need a mediator since anonymous parties can conduct fair transactions without authority or even any law that requires them to do so. Trust is coded into the smart contract itself, so there’s no need for centralization around any financial, legal, or law enforcement authorities.
Bankless Management Of Finances
Through blockchain technology, you can manage your finances without using a bank. We’re not quite there yet, so most of us instead have legacy finance accounts alongside crypto wallets and may need to pay taxes whenever crypto is converted into fiat currency.
The goal of the revolution is to excise banks and other financial institutions from the process of sending and receiving money, as that is where power (and sometimes corruption) gets centralized. Here’s how they become obsolete:
- Through holding crypto in digital wallets, banks aren’t responsible for holding your money.
- Trust is built into the system via smart contracts, with no need for mediators and intermediaries.
- KYC procedures are also built into the system since everything is cryptographically secured and distributed.
Companies can and have launched crypto to circumvent the stock market when it was beneficial to them, as we saw with the Overstock digital dividend.
Without banks and governments managing our finances, borders become almost irrelevant when sending and receiving money. Borderless finance is another aspect of DeFi that makes it revolutionary if it becomes mainstream. By eliminating the middlemen associated with trades and transactions, those transactions happen faster and cost everybody less, even when sending across borders.
24/7 -> 365 Availability
Banks and other institutions also need to close at the end of the day. Employees need time to rest but, with DeFi and automated smart contract transactions, there’s no need for employees to be involved. Instead, both parties can trade crypto with one another instantly and at any time of the day, every day of the year.
Currency Agnostic Payments
Agnostic payments are payments where there is no preference for any one currency. This means that, in theory, all cryptocurrencies will be supported for trade and exchange. People will be able to send and receive using different currencies, and exchange between them freely, without any extra demands or fees placed on them. Particl is a platform that wishes to achieve cryptocurrency agnosticism.
Decentralized Markets For Credit, Loans, & Lending
We’ve talked a lot about the trading of cryptocurrency so far but that’s just one part of our financial system. In centralized crypto finance, you can take CeFi loans out by borrowing against your cryptocurrency holdings as if they were collateral. How does DeFi work with credit, loans, and lending?
In a decentralized financial system, there is room for platforms based on lending. Certain protocols that currently exist, like Aave or MakerDAO, let entities take out loans and deposit digital coins for exchange. Right now, they are based around stablecoins that are less volatile than your average crypto project. DeFi lending also comes with different Annual Percentage Yields (APYs) attached, just like banks.
How can the money be loaned on decentralized platforms if the parties don’t know one another? Where a bank might check credit history, DeFi platforms instead ask borrowers to put forward some reserve funds that the lenders take if the loan isn’t repaid.
How DeFi Will Impact Investing (& Already Is)
Similar to our last point, there’s also more to the financial world than just exchanging and lending currencies. There is also investing, where we buy and hold assets so that they appreciate in price and yield returns for the holder.
DeFi isn’t just changing how we invest in stocks and derivatives; it’s also inventing entirely new areas of investment through NFTs and the metaverse. Here is how DeFi is already changing our investment habits.
NFTs & Art
First, let’s talk about NFTs. They are all the rage lately but they’re also a sorely misunderstood technology that has crazy implications for the future of investing and data management.
Right now, NFTs are being defined by the digital art market that has rallied around tech. This started when an artist known as Beeple sold a collection of his art as an NFT for $69 million. The piece was called Everydays: The First 5000 Days, which covered more than 13 years of his art career. That’s a lot of work from a bona fide artist, so the valuation made some sense, but what followed was an explosion of randomly generated digital art getting pushed by influencers, inviting rampant speculation into the space.
While it’s a useful proof of concept, it’s a very narrow expression of what NFTs are capable of. NFTs are just Non-Fungible Tokens, the data contained within them can be anything. They can be audiovisual too and many artists have since turned their songs into NFTs. What’s more, it’s even possible to program royalties into an NFT, so if you sell it to somebody and then they sell it again, a percentage will automatically get cut away and sent to the original minter. That would cut the middlemen out of the music and book industries, too.
If you struggle to understand NFTs, think of them like baseball cards. The NFT occupies a space on the blockchain that’s displayed via a public key, so everybody can see it, and then somebody owns the corresponding private key that proves they own it. This relationship has been compared to owning the deed of land and the key to access that land. You can copy the image represented in an NFT but you can copy a baseball card too, it doesn’t copy the value that is tied to it.
Stocks & Bonds
For a more traditional example of how DeFi is impacting investing, let’s take a look at stocks and bonds. As it stands, everything in our stock market is centralized through institutions like Wall Street and other overseas stock exchanges. With that centralization comes some distrust, especially when somebody abuses the system or a crash looms due to institutions’ speculation.
We have already mentioned the Overstock situation, where they issued a digital dividend and fought a lawsuit to force short sellers to close their trades on the Nasdaq. This was a rare instance of legacy finance using the benefits of crypto to benefit the company, something we can expect to see more of in the future.
As for wholly decentralized exchanges, some countries have expressed interest and in late 2020, we saw the launch of the Injective Protocol. It uses blockchain oracle tech to ferry market information into the blockchain, where you can then buy and trade stock like Amazon and Google.
Real Estate (Tokenized & Metaverse)
With the rise of cryptocurrency, we have also seen the development of tokenized and metaverse real estate. These are very similar to NFTs, and in some cases even use the same ERC-721 Non-Fungible Token standard, as they take a real estate space and then create a unique token that corresponds to its ownership. Projects like Earth 2 enable the buying and selling of virtual representations of land.
Then you have the metaverse. Facebook’s recent name change to Meta has brought a lot of eyes to the metaverse, which are virtual spaces that typically make use of VR tech. They allow you to exist in a simulated world where you can trade, enjoy activities, and you probably see where this is going. Projects like Decentraland and the Sandbox are rudimentary metaverse-like worlds where you can buy MANA or SAND, unique tokens which then correspond to individual plots of land you can buy, develop, and sell.
Derivatives are perhaps one of the most confusing aspects of the stock market. They are essentially contracts that speculate on the value of an underlying asset, or group of assets, and so they can be quite volatile if those assets pop or drop. Options and futures are popular examples of derivative contracts.
With that understood, it’s no surprise that the DeFi revolution is making services that are similar to derivatives. Naturally, smart contracts are the key here. As code-based agreements that draft themselves based on currently available information, they can be used to track the underlying crypto asset and change the agreement as needed. Then, when you close your position, the contract gets executed. This will allow investors in DeFi to hedge against their open positions.
The Major Cryptos Leading This Financial Revolution
To finish off our guide, we have some of the main cryptocurrencies you should pay attention to if you’re anticipating a financial revolution. These are established coins that have proven they have what it takes to survive the current market and become mainstream in the future, dethroning legacy finance.
Almost synonymous with crypto at this point, Bitcoin is the project that started it all. Created in 2009 by the mysterious ‘Satoshi Nakamoto,’ its aim was to be a decentralized digital currency that was kept honest by scarcity since only 21,000,000 of them exist and not all of them have been mined yet.
After a decade of staggering price appreciation, Bitcoin exploded in recent years by going from $10,000 in September of 2020 to $57,000 today, solidifying its place as the gold of cryptocurrency. It came first and is the most valuable, and it can go even higher than it is right now.
As we’ve already covered, Ethereum is the largest blockchain in the world. Its proprietary cryptocurrency is called Ether, though many just call it Ethereum for ease of reference. Ethereum went live in 2015 after programmer Vitalik Buterin crowdfunded the project. While Bitcoin was the start of cryptocurrency, Ethereum made the deployment of decentralized apps possible for many people. Most NFTs are also facilitated through Ethereum’s ERC-721 tokens.
Like Bitcoin, Ethereum also experienced a massive price increase recently, going from $400 in December of 2020 to nearly five thousand. If the Ethereum blockchain continues to be the largest and is the one that goes mainstream in the future, then Ether may be a good investment.
Built on Ethereum, Chainlink is a blockchain oracle network created in 2017 by Russian entrepreneur Sergey Nazarov and lead developer Steve Ellis. A blockchain oracle is simply a service that connects smart contracts to real-world data. The main goal is to funnel information from the real world so that smart contracts can stay accurate or react to real-world happenings.
Naturally, being the largest decentralized blockchain oracle puts them in an advantageous position if Ethereum is the blockchain of the future. If that happens, Chainlink may be the bridge that connects the blockchain to the real world when transferring funds and conducting other online business.
UniSwap is the largest decentralized exchange currently available, having appeared in 2018 after development by Siemens engineer Hayden Adams. Where centralized crypto finance relies on brokerages, UniSwap is a decentralized finance protocol that, again, works on the Ethereum blockchain.
Through smart contracts, it allows us to swap one cryptocurrency for another, providing a way to convert currencies without requiring service to do it for you. If the finance revolution uses the Ethereum blockchain, UniSwap may be the way most Ethereum-based tokens are exchanged.
Founded by Australian investor Kain Warwick, Synthetix is a DeFi protocol that allows for the creation of synthetic assets on the Ethereum blockchain. This makes it pretty much the equivalent to derivative investing, where you use smart contracts to track the performance of other assets that you don’t hold, and then make or lose money based on that asset’s price movement.
MakerDAO is a decentralized autonomous organization, which is a group that makes, follows, and votes to change transparent rules that are coded into the software projects they collectively own. It was started by Danish entrepreneur Rune Christensen and his cohorts, and it has received funding from venture capital firms, being one of the first widely adopted DeFi protocols.
In this case, MakerDAO owns Dai. It’s a stablecoin cryptocurrency, which means it is pegged to the value of the US dollar. If the DeFi revolution happens then there’ll need to be more stable crypto, unlike Bitcoin or Ethereum, and Dai could be just that.
Aave is a decentralized lending system that enables its users to lend and borrow crypto assets and then earn interest on the crypto that they own. It was started by Stani Kulechov as ETHLend after the developer saw the potential for Ethereum-based DeFi and how it could change our current financial systems.
Enjin is a project that’s based out of Singapore that specializes in integrated NFTs, which are NFTs that can be traded but also included within games or apps, making them much more valuable in terms of their use. For example, a game can give NFTs as rewards that give players benefits in-game, and then you can trade that to somebody else so they can get the benefits too. Assuming standardization between games, it may even be possible to transfer in-game NFT items across games. This emerging field is known as GameFi.
So, Will Crypto Revolutionize Finance?
Now that we have covered how crypto and DeFi can revolutionize finance, it’s time we ask – will it actually happen? We think yes, though the extent of DeFi adoption won’t be consistent across the finance sector. For example, we are already seeing projects that can facilitate a DeFi revolution if they become more popular than legacy finance, though legacy finance will probably still exist in some form.
Away from the explicitly financial matters, GameFi is already emerging but whether play-to-earn tech and NFTs survive beyond the current trend remains to be seen. If NFTs do survive, the tech could create a burgeoning industry of freelancers and hobbyists who can make money gaming and making royalties by doing what they love.
Whether all of these projects survive is a different thing. At this point, there’s no doubt that there’s a place for DeFi crypto trading in the future. Some think world governments will mint their own crypto in an attempt to centralize it and create a hybridized system, which may make DeFi a niche that isn’t pursued to its full potential.