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Now that we’ve covered the basics of blockchain and cryptocurrencies, you’ll be able to make some connections around how blockchain technology might just change the financial landscape. 

This chapter will introduce you to Decentralized Finance (DeFi) and demonstrate where DeFi fits in the current traditional financial system.

Let’s start by recapping traditional banks as centralized financial institutions.

Although they offer different types of services, let's use one example to show how the current system works. 

Say you want to transfer money to someone.
![image1.png](https://wow-studio-foundation-cms-staging-public.s3.amazonaws.com/image1_8fdb4ce1f6.png)
You may need to visit a physical bank and have an employee assist you with the transfer. Once approved, the money will be sent to the receiver’s bank and then to their bank account. 

While smartphones and internet devices have reduced the need for physical visits to banks, there are still several steps required for a successful transaction. 

One of the issues with traditional banks is time. A pain that you or someone you’re close to might know a little too well.

There can be a long process of filling out extensive documentation to verify compliance with anti-money laundering laws (AML) or some other regulation. 

Even after you pass this process and initiate the transfer, there can still be a significant time delay in the time it takes for the funds to arrive in the receiver’s bank account. 

Sure, the duration of the delay depends on the country, the currency used, and whether you have access to online banking and/or whether you’re attempting to make a domestic or international transfer. All in all, dealing with banks can be a slow and difficult process because of the human element involved.

At the end of the day, the main goal of a bank is to make money. They do this by earning interest on the loans they issue and charging fees for their services.

Banks assist customers in various ways, like:
- approving deposits and withdrawals
- facilitating domestic and international transfers
- offering credit lines or loans to individuals and businesses
- advising customers on where to invest their money

They’re also responsible for safeguarding their customers’ hard-earned money, offer financial advisory services, and stimulate economic activity and development. 

These safeguards and limitations indicate that they are centralized entities. With that, comes limitations. 

Traditional Finance

Traditional banks are the lungs of the financial world. 

A key part of what they do as an intermediary is connect borrowers and lenders together. 

If something goes wrong, you can call (or go to) your bank for assistance. Just like any other intermediary, they exist to establish trust and help parties find and deal with each other.  

Without banks, access to reliable and safe access to loans, savings, or other financial services would be limited or nonexistent.

So, if they’re here to help us carry out safe and reliable transactions, what’s the problem?

**Here’s the first issue.** 

When you open an account with a bank, you trust them with your money and private information.

You do so because banks are typically trusted institutions in society, and because there aren’t many alternatives.

Now, even though the account belongs to you, it is still controlled by the bank. 

_So why is that a problem?_

Banks have the power to close your account at any time without a reason or explanation if they have concerns about the activity taking place.

It’s similar to Instagram, Twitter, or other social media platforms. If either of these social media platforms believe you are violating a rule in the content you post, they might close your account. 

And there’s not much you can do but appeal for them to give your account back to you. If they say no, well, you lose all your followers and the content you have made.

Pretty unfair if you spent hours a day producing and writing content, eh?

The same applies to banks. 

If they think you are violating a regulation, they might freeze or close your account even if you’re not aware of the violation you have made. 

You would then need to appeal to get your account back which can take weeks, if not months.

**What’s the other issue then?** 

Well, banks hire humans, and all humans make mistakes from time to time. Even in our personal lives, we sometimes drop our phones, forget where we left our keys, or trip ourselves when walking.

In the work setting, we might make an input error on a datasheet, forget to do a task we were assigned, and there might be miscommunication when talking to customers or colleagues.

But what happens if it’s not just an input error on a datasheet? What happens if hiring the wrong people ends up leading to mismanagement, bad investments, or corruption? 

Banks are not immune to mispractice. The limitations we just talked about were evident in the Global Financial Crisis of 2008 and many previous market crashes.

The economic crash of 1929 was largely caused by uncontrolled stock market speculation. Something similar happened in 2008 because of real estate speculation and fraudulent behavior by greedy actors. 

Loose regulations failed to keep everything in check, so there was a lot of excessive risk-taking. 

Many borrowers couldn’t repay their loans they had taken out, putting the banking system under severe stress.

> _The lack of transparency in the financial system resulted in bad investments and malpractice. This was a watershed moment for DeFi._ 

Shortly after the housing market crash, _bitcoin.org_ was registered. 

While some have speculated that this was in response to the financial crisis, it appears to be a mere coincidence as work on Bitcoin began in early 2007, before the market crash occurred.
 
On October the 31st, 2008, the mysterious Satoshi Nakamoto released a whitepaper titled: “Bitcoin: A Peer-to-Peer Electronic Cash System.” 

This invention started a chain of events that ultimately led to the creation of DeFi on the Ethereum years later.


Limitations of Banks

Now that you have a good understanding of traditional finance, it’s time to cover the ins and outs of DeFi.

DeFi enables users to borrow, lend, trade, and transact without intermediaries, and all of this is made possible through blockchain technology. As an infant industry, individuals and businesses are exploring new ways and features that can be built within this ecosystem.

While both Bitcoin and Ethereum use blockchain technology, most DeFi activity occurs on Ethereum due to its smart contract functionality. Smart contracts allow DeFi applications to overcome the limitations of traditional financial institutions by reducing human errors and mitigating greed through blockchain’s transparency. Additionally, services can no longer be gatekept.

> 📑 Smart contracts are covered in a later chapter, but if you want to skip ahead, feel free to do so. 

Blockchain technology is the foundation of DeFi. And DeFi encompasses a wide range of financial applications built on top of this network.

DeFi applications generally share the following characteristics:
- Decentralization: users deal directly with each other, without intermediaries like a bank.
- Transparency: the blockchain provides a permanent and immutable record of transactions that anyone can view, verify and audit at any time.
- Open and permissionless: accessible to anyone with an internet connection, regardless of location or identity.


DeFi: In code, we trust?

DeFi provides a decentralized financial marketplace accessible to anyone worldwide via their phones. In contrast, traditional finance is often associated with gatekeeping access to financial services, with high barriers to entry, such as the requirement of an address or credit score.

Let’s take a real-world scenario to illustrate this point. 

Now, someone running a flea market booth in Jordan can borrow funds at a competitive rate that a banker in England would have the same access to, just through a decentralized lending protocol from his or her device. 

Additionally, someone can place funds into what is called ‘yield-farming’ as a hedge against the inflation of their domestic currency. Yield farming basically means lending or borrowing crypto on a DeFi platform to earn cryptocurrency rewards in return for their services. 

So people who were previously excluded by the existing financial system now have the ability to get involved. DeFi is more efficient, gives more access to opportunities, and is more transparent than traditional finance.

In short, DeFi can help level the playing field for people around the world trying to get access to secure financial services without the need to be at a certain financial level. This is what the promise of web3 is all about: inclusion. 

DeFi is changing the digital landscape: here’s why it matters

Defi.svg

DeFi 

How do I use web3? 

Now that you have a good understanding of traditional finance, it’s time to cover the ins and outs of DeFi.
DeFi enables users to borrow, lend, trade, and transact without intermediaries, and all of this is made possible through <a class="glossary-term" data-tooltip-id="term-8">blockchain</a> technology. As an infant industry, individuals and businesses are exploring new ways and features that can be built within this ecosystem.
While both <a class="glossary-term" data-tooltip-id="term-10">Bitcoin</a> and Ethereum use <a class="glossary-term" data-tooltip-id="term-8">blockchain</a> technology, most DeFi activity occurs on Ethereum due to its <a class="glossary-term" data-tooltip-id="term-93">smart contract</a> functionality. Smart contracts allow DeFi applications to overcome the limitations of traditional financial institutions by reducing human errors and mitigating greed through blockchain’s transparency. Additionally, services can no longer be gatekept.
<blockquote>
 📑 Smart contracts are covered in a later chapter, but if you want to skip ahead, feel free to do so. 
</blockquote>
<a class="glossary-term" data-tooltip-id="term-8">Blockchain</a> technology is the foundation of DeFi. And DeFi encompasses a wide range of financial applications built on top of this network.
DeFi applications generally share the following characteristics:
<ul>
<li>Decentralization: users deal directly with each other, without intermediaries like a bank.</li>
<li>Transparency: the <a class="glossary-term" data-tooltip-id="term-8">blockchain</a> provides a permanent and <a class="glossary-term" data-tooltip-id="term-50">immutable</a> record of transactions that anyone can view, verify and audit at any time.</li>
<li>Open and permissionless: accessible to anyone with an internet connection, regardless of location or identity.</li>
</ul>

Now that you have a good understanding of traditional finance, it’s time to cover the ins and outs of DeFi.

DeFi enables users to borrow, lend, trade, and t...

DeFi: In code, we trust?

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DeFi: In code, we trust?

Thank you for the feedback! 💜

More related chapters

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