On September 18, 2021, The Economist, the British business newspaper, placed an illustration of Alice in Wonderland on its front page to talk about decentralized finance. What is decentralized finance? And why does this Economist cover herald a new era?
Decentralized Finance, or Alice in Wonderland
Decentralized finance, or DeFi, is a new kind of finance, which draws its strength from the use of blockchain technology. Indeed, most financial technologies today are centralized. All transactions must be verified by central actors. The best known of these actors are banks, but there are many others, such as central depositories, stock exchanges, insurers, etc. These central actors usually get paid in the following way: every time there is a transaction, they take a commission.
With blockchain and decentralized finance, these central actors, as we know them, are no longer involved!
Blockchain is a technology that was born with Bitcoin, and it is still evolving. The blockchain is a register distributed among several computers in the world, and on which transactions are recorded. There is the Bitcoin blockchain, but there are many others, including the Ethereum blockchain. The latter has allowed a boom in possible use cases, because on the Ethereum blockchain, it is possible to develop applications, known as decentralized applications, which run on computers distributed throughout the world.
The new kings of the world
In 2018, the decentralized application Uniswap was created. Uniswap is the first major decentralized finance app. This decentralized app is revolutionizing finance, plain and simple. In centralized finance, all transactions go through central players. In decentralized finance, all transactions go through the blockchain, and what is revolutionary is that all the participants in the blockchain can play the role of central players, and therefore recover commissions on transactions. On Uniswap, it becomes possible to deposit bitcoins and to be remunerated in return. The bitcoins will serve as a liquidity reserve, and will be automatically managed by the blockchain. This is one of the applications of decentralized finance, but many others have been created since. Sushiswap, AAVE, Venus, Compound... are all decentralized applications that are revolutionizing their field.
Alas, like everything that glitters, decentralized finance has a dark side. Behind the wonderland, some people take advantage of the excitement to fleece others, with mechanisms often inspired by the Ponzi pyramid. But despite the unfortunate scams, the technological revolution is real. And The Economist recognizes that decentralized finance could be the beginning of a revolution, as the internet was in its time. In 2015, The Economist was able to identify the blockchain technology revolution behind bitcoin, in a famous piece:
At a time when bitcoin was considered the currency of the Dark Web, The Economist wisely identified the revolutionary technology of blockchain.
6 years later, this technology is producing decentralized finance, which could shake up multi-century old banks. And that's why this Economist cover story ushers in a new era of complex competition between centralized and decentralized finance.
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