It alludes to that phenomenon defined as decentralized finance (in English, Decentralized Finance or DeFi), or an emerging ecosystem of financial applications and protocols built through the organization of services, similar to banking, built on infrastructures that presuppose the absence of hierarchies, such as the blockchain, or in any case less centralized than the banking system. One of the relevant features of this type of projects is represented by the automatisms that allow transactions to be carried out without external intervention, often based on the enormous strength of smart contracts.
Smart contracts, literally intelligent contracts, represent an incorporation of contractual clauses encoded in computer language, software, or computer protocols, which are used for the conclusion of contractual relationships by giving autonomous execution of the programmed terms upon the occurrence of certain conditions.
Smart contracts, despite presenting themselves as tools used to negotiate, conclude or independently apply contractual or pseudo-contractual relationships, cannot be included in the category of legal contracts. The reason can be found in the fact that they have technical and technological peculiarities that do not allow them to be combined with the pure and simple computerized or digitized version of a contract. In practice, users do not have a financial services company as their contractual counterpart but find themselves interacting with a computer-controlled market that allows the automatic execution of transactions, such as the issuance of loans secured by cryptocurrencies or the payment of interest. on equity investments. It is also interesting to note how most Defi platforms are structured to become independent from their developers over time and to be ultimately governed by a community of users whose power derives from the possession of the protocol tokens.
How much is the DeFi economy worth
Decentralized Finance is still in the early stages of its evolution, but already as of October 2020, over 11 billion dollars have been deposited in various decentralized finance protocols, a figure that represents more than tenfold growth in 2020. Currently the DeFi economy is worth about $ 100 billion. In the wake of this seemingly uncontrollable growth, the Nasdaq has even decided to create a stock market index (DEFX) to keep track of the major DeFi products. There are currently around 200 DeFi projects and 90% of them exploit the Ethereum network.
Comparing them to traditional banks, DeFi platforms are apparently very similar, but appearances are often deceiving. The most significant example is BlockFi, which, with its BlockFi Interest Account, represents the most institutionalized solution in this area, as it is supported by the likes of Coinbase Ventures, Morgan Creek Capital Management, Winklevoss Capital and others. On this platform, consumers deposit cash or cryptocurrencies earning monthly interest, as if they were dealing with a bank.
But a big difference is the interest rate; In fact, depositors can earn a hundred times higher return on BlockFi than on average bank accounts. Another big advantage is the ease of use: to start earning interest you simply need to make a deposit in one of the supported cryptocurrencies.
The benefits of decentralized finance
The spread of decentralized finance phenomena has stimulated the first value judgments on the current phenomenon. Many observers argue that crypto finance promotes financial inclusion. In other words, people who for a long period of time have been excluded from accessing traditional banking institutions, now have the opportunity to engage in transactions quickly, cheaply and without prejudicial obstacles.
These solutions offer the opportunity to eliminate the difficulties of many related to the possibility of finding a personal loan that costs little, possibly based on deposit accounts that offer decent returns, even in the face of a credit situation that is not excellent, a typical case of private approach with traditional banking institutions. In fact, alternative service platforms generally do not require credit checks, although some take identity information from the customer for the purposes of making the required tax and anti-money laundering reports. It should also be added that on a DeFi protocol, users’ personal identities are generally not shared, as they are judged solely by the value of their encryption.
But not all that glitters is gold: the risks of DeFi
Once again, however, not all that glitters is gold. Although the financial services offered by crypto platforms are more advantageous in terms of profit, there is a growing phenomenon whereby consumers are unwittingly taking significant risks by using these products. First of all, while cryptocurrencies have gained popularity over the years, they remain extremely volatile, as has clearly emerged on the occasion of the collapse in the price of Bitcoin and Ethereum in recent months.
Obviously the interests of crypto current accounts can be highly attractive, considering their high yield, but if the platform itself that provides the account or the cryptocurrency goes bankrupt, the investors’ assets will obviously not be guaranteed as it would be in a traditional bank (think of operations of the Interbank Guarantee Fund) or in a traditional investment account.
Another problem inherent in DeFI is represented by the fact that such applications often represent disintermediation of traditional authorized operators, such as banks and supervised intermediaries, who usually play an almost “governmental” role in traditional finance, collecting and communicating data to the authorities, including information on capital gains on investments made by their clients, including with a view to ensuring the payment of taxes. In other words, customer market participation in the approach with traditional operators depends on compliance with strict rules of conduct. In contrast, DeFi programs are unregulated applications, created by programmers more interested in realizable gains on capital markets than in complying with the rules.
It should also not be overlooked that, despite their greater security resulting from the use of blockchain technology, cryptographic networks can still be vulnerable to hacker attacks and fraud, and there are insufficient regulations to protect consumers in these cases.
The reaction of the banks
In this context, traditional banks have reacted on the one hand by asking regulators to slow down their crypto competitors, on the other by starting to work with cryptocurrencies.
Both Visa and Mastercard have announced plans to bring crypto to their networks, and major banks around the world have invested hundreds of millions of dollars in blockchain companies.
Traditional financial institutions are likely to continue to integrate blockchain technology and cryptocurrencies into their products and services. On the other hand, cryptography enthusiasts and new operators linked to the DeFi world will have to be ready to implement government regulations which, ideally, will provide greater stability and protection, with consequent slowing of the benefits that the new comers of the DeFi galaxy currently enjoy.
New DeFi traders may not be required to collect customer information like traditional banks, but regulators could create new standards and requirements for technology and products, such as enforcing code audits and setting strict risk parameters.
The battle between traditional financial operators and the DeFi world has just begun and the outcome appears uncertain.