Decentralized Finance (also known as DeFi) is an ecosystem of financial applications built on top of blockchain networks.
But what does this mean?

If you aren’t familiar with modern blockchain applications such as Ethereum’s Decentralized Applications (or dApps), think of them as open source, distributed applications or services that are accessible by anyone that has access to the internet and has an Ethereum wallet.
The DeFi ecosystem is made of dozens of different dApps that share the objecting of porting and improving financial instruments to the blockchain.

This probably sounds very vague to anyone that isn’t familiar with dApps, so let’s look into a DeFi application.

Aave Protocol - Money Markets on the Ethereum blockchain

Aave is a protocol built on Ethereum that enables the creation of money markets. Users can lend or borrow assets through these markets, and earn interest on their deposits.

Sounds familiar to you? Probably so, because that’s the basic definition of loans.

So, why should you go through the trouble of using Aave, possibly with stable coins (crypto assets pegged to the US Dollar), instead of just using the services offered by your bank?

I’ll let the numbers do the talk:

  • According to Investopedia, as of September 2020, the highest bank yearly interest rates are around 1.00% to 1.10%
  • Currently, Aave offers around 12% yearly returns on the stablecoin DAI.

The Bleeding Edge

From a theoretical standpoint, DeFi sounds awesome.
It offers much, much better returns than traditional finance and it’s only getting started!

So, what’s the drawdown?

Well, like many technological innovations, DeFi is considered to be on the bleeding edge of crypto and Web3.

Bleeding edge technology is a category of technologies so new that they could have a high risk of being unreliable and lead adopters to incur greater expense in order to make use of them.

What does this mean?
For starters, that you should be extremely careful when using DeFi dApps.
Like all bleeding edge technologies, DeFi consists of experimental tech that hasn’t really passed the test of time.

Given how much money is locked in these protocols (as of September 2020, over 8 billion USD!), hackers are incentivized to look for bugs to exploit, and new scams are perpetrated each day.

For example, last June the DeFi protocol Balancer was hacked for over $500.000 in cryptocurrencies.

But this is the risk that it takes to be on the bleeding edge.
Venture capitals like Three Arrows Capital and single investors that have decided to speculate on Decentralized Finance have decided to face these risks, and have experienced tremendous returns in the past year.

For instance, the Aave token has experienced a rise in its market price of an outstanding 4000% in the past year.

The DeFi VIPs

To end this blog post, if you’re interested in learning more about DeFi, I highly suggest watching the DeFi Roundtable from Smartcon 2020 to see what the DeFi industry leaders think of the current state of Decentralized Finance.