Decentralized Finance (DeFi)
By GITTEL AYUK Esq.
What is DeFi?
Cryptocurrency is best known by many as a digital currency. But is cryptocurrency Money? Different people including banks, academicians, Crypto enthusiast, economists and government agencies hold quite opposing views of what cryptocurrency really represents. To some, Cryptocurrency is money; to others an assert or security. In this article, we shall analyse these different views i.e., whether cryptocurrency is money or an asset or both money and an asset. To this effect, we shall examine some underlying concepts such as Money, Assets, Cryptocurrency as Money and Cryptocurrency as Assets.
DeFi is a contemporary Financial Technology, built on blockchain technology, which allows people to perform financial transactions directly without the need of any middleman. A better way to understand DeFi is to understand what it is and how its predecessor, Centralized Finance (CeFi) works.
Traditionally, banks and other financial institutions serve as middlemen and a control mechanism on issues of how people save, use and transfer their money, take loans or enjoy other financial products. As a reward for “safeguarding” the money of people, the middlemen earn fees and interests. Middlemen like banks benefit from interest, lending out the money of people which they have in their keepings. High interest rates are charged on these loans and it is shared with the real owners of the money; only that, the sharing is disproportionate, as the owners are paid just a minimal sum from their savings as interest. This, and many other practices of CeFi, is the very antithesis of DeFi. While CeFi exalts the role of Middlemen, DeFi eliminates it in its entirety. DeFi valorises Peer to Peer (P2P) transactions, giving people the liberty to have full control of their money, how it is being managed, who it is being borrowed to and how quick it is transferred.
How DeFi Works
DeFi is a system of financial operations powered by blockchain technology[1]. Blockchain is a distributed ledger technology where transactions are authorized and performed by individuals without approval from a middleman or regulator. Blockchain is acclaimed for its democratization of financial transactions and its elimination of risk and fraudulent tendencies that are common with the traditional financial systems. Transactions performed on blockchain are encrypted and interlocked with a series of uncountable transactions, forming blocks of chains that cannot be alternated[2].
[1] Decentralized Finance (DeFi), Available at, Decentralized finance (DeFi) | ethereum.org.
[2] Rakesh Sharma, 2022, Decentralized Finance (DeFi) Definition, Investopedia, Available at, Decentralized Finance (DeFi) Definition (investopedia.com).
The use of Cryptocurrency is central to the success of DeFi. DeFi permits peers to carry out transactions directly with people of their choice with the use of Cryptocurrencies like Bitcoin and Ethereum. To establish trust, smart contracts have been introduced to create legally binding relationships between peers by the use of technologically facilitated and automated terms which authenticates their obligations. P2P transactions can include buying of goods and services, money transfer, saving and lending of money and even insurance coverage. So, instead of effecting a payment for goods and services with the use of a credit card, where the transaction will pass through middlemen like a merchant acquiring bank and a credit card company[1], DeFi permits individuals to evade all the above middle men and obviously, the fees which would have gone to them. Instead of saving money with banks and getting nothing, people can save their money on DeFi platforms and get complete interest on the sum.[2] In like manner, people can borrow money from other people in a DeFi platform (P2P Lending) or from a pool of funds made available by DeFi Lenders.
[1] Ibid.
[2] E. Napoletano & Benjamin Curry, April 8, 2022, What is DeFi?: Understanding Decentralized Finance, Forbes Advisor, What Is DeFi? Understanding Decentralized Finance – Forbes Advisor
What Challenges does DeFi face?
As promising as it may sound, DeFi is still a nouvelle innovation and its performance is not at its optimum yet. A number of challenges still surround the innovation, most especially, security. This is an aspect which CeFi still has a leverage over DeFi. As of now, many may agree that money in the bank is more secured than money in a DeFi wallet which can be hacked at any time. With CeFi, if a customer’s money is stolen from the bank, it’s the bank’s responsibility to restore the customer to the position he or she was before the theft occurred. But this is not the case with DeFi, which is still largely unregulated in many countries.
The absence of a law regulating DeFi is a major challenge to its progress. Cryptocurrency which is the money used for DeFi transactions is unregulated in most countries, some have even put an outright ban on it, declaring it illegal.
Conclusion
Despite these challenges, the adoption of DeFi by individuals has been geometric. Many still approach the new invention with much optimism as they see it as placing power in the hands of the common man. As the existence of Centralized institutions is being threatened, some CeFi institution are either integrating DeFi into their system, partnering with DeFi institutions while others have chosen to maintain their “traditional” models.