Everbloom's Vision on DeFi
According to us at Everbloom, Decentralized Finance is one of the biggest innovations coming from the cryptocurrency technology space in the past few years. We explore what Decentralized Finance, or “DeFi”, really means as the term is often misused and quite frankly, poorly understood. We articulate our vision for this future of finance made possible through public blockchain infrastructure.
This idea of DeFi sprouted at the beginning of 2020 and took root with the development of smart contract protocols that provide certain financial utilities, initially developed on the Ethereum blockchain . Important is not to purely focus on ‘what' is being done, but rather to dig deeper and inspect ‘how’ it is executed and which properties these system are able to achieve.
Let’s zoom in on the “Decentralized” aspect of this new and exciting world. “Decentralization” must be one of the biggest keywords when thinking about cryptocurrency technology. This idea to not have single points of failures but to distribute control and verification across the whole network is extremely powerful.
We have Bitcoin to thank for this incredible new paradigm. While Bitcoin focusses on payments and utility as a form of hard money, other project were inspired to replicate the properties of the Bitcoin system for other use cases, such as arbitrary code execution. Ethereum was the earliest and most successful layer-1 blockchain to offer decentralized execution and birthed the concept of smart contracts.
“Smart contracts” is another one of these poorly chosen terms that has taken hold over the years. They are not really contracts and are also not particularly smart. A smart contract is a piece of code that has been deployed to a blockchain and that offers some sort of functionality for users or other smart contracts to interact with. This enables new and exciting properties for smart contract based systems. For example, smart contracts offer “verifiable and secure execution of code”, without censorship or manipulation by external entities. Smart contracts build on top of the consensus layer of the underlying blockchain, meaning that the security and absoluteness of the smart contracts is as strong as the security and decentralisation of the blockchain itself.
In short, smart contracts allow you to execute a piece of code without anybody stopping you from doing it, without anyone manipulating the result. And best of all, anyone can verify those properties about your code and its execution. This enables a bunch of interesting use cases, especially financial applications as they greatly benefit from these properties.
As such, Decentralized Finance became this container term for a parallel financial world that exists purely on-chain. While ownership and governance over these smart contract protocols is not always truly decentralized, the fact that the code runs on a public blockchain with sufficient decentralisation properties led to the naming. Perhaps “on-chain finance” would be a more accurate description.
The building blocks of DeFi are smart contract protocols. Protocols are a collection of smart contracts, providing reliable and verifiable execution, that offer a specific financial utility function to users or other smart contracts. Key ideas here are composability, re-usability, transparency and open-source code. Settlement happens as fast as the speed of the blockchain allows and smart contract protocols replace traditional financial middle men. We see protocols focussing on specific verticals in finance, such as lending and borrowing, digital asset collateralization or token swaps. They work together and complement each other while extending the power of DeFi. Protocols revolutionise the value creation process of financial applications. Instead of having very top-down hierarchy in terms of decision making and ownership structure, protocols are often community-driven and community-governed. Users are not merely clients but can be full-on participants in protocol governance or earn fees and incentives from using the protocol or supplying valuable liquidity.
It is no surprise that DeFi aims to improve our current financial world. The status quo of traditional finance is a slow and opaque system with lots of costly regulation and huge barriers of entry for innovators. It takes a long time to settle simple transactions and middlemen extract a lot of value in return for providing a subpar service. High fees and rent-seeking plague banks as they are moving away from offering consumer payment services to focussing on clients who have assets they can manage to claim their management fees.
The financial system has known the least amount of innovation out of all industries. We are still using credit card technology from the 1960’s for the majority of our online payments. Thanks to blockchain infrastructure we now have the tools to reshape the way we engage with our financial assets.
This is the true promise of DeFi, an ever-growing and ever-improving experiment happening in plain sight for all to observe and learn from. We are still so early in the adoption phase of this new technology. It has its growing pains but the open-source nature of the system makes it so we document and learn from past mistakes. It certainly has shortcomings in its current iteration. None of these are fundamental problems of the paradigm but rather short-term technological and sociological constraints that will phase out over time.
We truly believe that a novel financial paradigm was born and is growing everyday. The properties of this technology are vastly superior to the old legacy financial system. This movement which captures the heart and minds of ambitious developers is simply too strong to ignore. While the old paradigm has failed us in leaving billions of unbanked people around the world, DeFi holds the promise to allow fair financial access for everyone on an unprecedented scale.
Given more time and development, DeFi or blockchain-based finance will replace our old trust-based financial system and become the global financial rails of the future. This is what Everbloom is betting on.