Decentralized Finance 101

8 May 2022

Design by Melpomenem

Finance has been a critical part of our economy and society for centuries. However, the way it is currently managed leaves a lot desired.

Centralized finance systems are slow, expensive, and easily manipulated by those in power. Decentralized finance (DeFi) is a new paradigm that aims to solve these problems.

It is built on blockchain technology and uses smart contracts to automate transactions. This makes it much more efficient and secure than traditional finance systems.

DeFi also offers greater transparency and security than traditional systems. Transactions are recorded on the blockchain, so they cannot be altered or deleted without being detected. This makes DeFi ideal for handling sensitive financial information.

The History of Finance

The history of finance is long and complex, with many different events and innovations shaping how we think about and use money today.

Finance is a term used in many different ways, but money management is core. It is an important part of our economy and our daily lives.

The first recorded finance instance was in ancient Mesopotamia, where they used silver coins to trade goods. Then, around 2500 BC, the Egyptians started using promissory notes, which allowed people to borrow money from each other. This was the first form of debt.

Beginning of the Early Banking Industry in Mesopotamia 

In 600 BC, the Greeks started using coins made out of bronze and copper. They also developed the concept of interest, which was charged on loans. This was an important step in finance development because it allowed for more complex transactions.

Throughout the years, there have been countless financial innovations that have helped to shape the industry as we know it today.

In the 18th century, for example, John Law created paper money in France, which helped stimulate the economy.

And in the 19th century, banks began issuing credit cards, making it easier for people to borrow money.

The complete history of credit cards, from antiquity to today

More recently, there have been a number of seismic changes in the world of finance.

Money 101

Some historians believe that money was invented in China, while others believe it originated in Greece or Rome. Regardless of its origin, there is no doubt that money has played a major role in human history.

Historians debate the origins of money, but it is generally agreed that the first forms of money were objects used for trade.

The origins of money are murky and mysterious | Science News

These objects were usually something that had a high value in society, such as precious metals or shells. 

Later, coins were invented to make transactions easier. Eventually, paper money replaced coins, and now we use credit cards and other forms of electronic payment.

Over time, different societies developed different money systems, but the basic idea remained the same.

The Ascent of Money - A Financial History of the World 

Money is a means of exchanging goods and services without resorting to bartering. It makes trade easier and faster and allows people to buy things they might not be able to get with just goods and services.

Money has evolved over the years, taking on many different forms.

Origins of Centralized Finance

The origins of centralized finance can be traced back to the Medici family in Italy during the Renaissance period.

The Medicis were a banking family who became extremely wealthy by lending money to royalty and other wealthy individuals.

History of banking 

They were also responsible for creating the first public bank, which allowed the common people to deposit their money and earn interest. This was a major advancement in finance, as it allowed people from all walks of life to participate in the banking system.

The French king eventually overthrew the Medicis, who created his centralized financial system known as the Banque de France.

This bank was responsible for issuing currency and regulating the banking system in France. It also served as a model for other central banks throughout Europe.

Centralized finance gradually began to spread worldwide, and by the 20th century, most developed countries had their central banks.

What is Centralized Finance?

Centralized finance is a financial system that concentrates monetary authority within a single government or regulatory body.

This system often features a central bank that issues currency and regulates the banking sector. In addition, centralized finance usually involves many financial institutions subject to government oversight.

Critics of centralized finance argue that it can lead to financial instability. For example, if the central bank makes mistakes in its policies or if there is a banking crisis, the results can be disastrous for the economy as a whole.

Additionally, centralized systems can be slow to respond to changing economic conditions.

Supporters of centralized finance argue that it provides stability and certainty for businesses and investors. In addition, they argue that it allows for more efficient allocation of resources and better risk management.


The 2008 financial crisis was a watershed moment for the world of finance. For years, the global financial system had been based on centralized institutions like banks and stock exchanges.

But the crisis showed that this model was no longer viable. Banks were too big to fail, and when they started to collapse, the whole system came crashing down.

In the aftermath of the crisis, there was a renewed interest in decentralized finance. This is a model where centralized institutions do not control money but instead flow through a network of nodes. This allows for more flexibility and resilience and increased privacy and security.

There are already a number of decentralized finance protocols in development, including Bitcoin, Ethereum, and Ripple.

These protocols can potentially reshape the way we think about money and commerce. They could also help to prevent another financial crisis from happening.

Origins of Decentralized Finance

In the past decade, there have been an increase in decentralized finance (DeFi) protocols. DeFi protocols allow users to interact with each other without relying on a third party.

These protocols have a variety of applications, including lending, borrowing, and investing.

One of the first DeFi protocols was Bitcoin. In 2009, Satoshi Nakamoto released the Bitcoin whitepaper, which proposed a new way to send money without relying on a third party.

A Brief History of Decentralized Finance (DeFi)

Bitcoin's blockchain was made possible, a distributed ledger that allows users to store and transmit data without relying on a central authority.

Since then, a number of other DeFi protocols have been developed. Ethereum is one of the most popular platforms for developing DeFi applications. Ethereum allows developers to create decentralized applications that run on their blockchain.

What is Decentralized Finance (DeFi)?

Decentralized finance, or DeFi, is a subset of the cryptocurrency industry that focuses on financial applications built on top of the decentralized infrastructure.

This includes applications like decentralized exchanges (DEX), lending platforms, and derivatives markets.

DeFi has seen rapid growth as developers have begun to build more sophisticated applications on top of blockchain infrastructure. This has led to a number of DeFi products achieving significant market traction, with some having raised over $100 million in total funding.

DeFi Is Now a $100B Sector - CoinDesk

The key benefits of DeFi products are that they are trustless and censorship-resistant. This means that users can interact with them without trusting any third party.

Additionally, DeFi products are not subject to government control or censorship, making them ideal for use in countries with repressive financial regimes.

DeFi Mechanics

In the world of decentralized finance, also known as DeFi, users can interact with each other without the need for a third party. This allows for a more trustless and egalitarian financial system.

In DeFi, three key mechanics enable this: smart contracts, decentralized exchanges (DEXs), and tokenized assets.

Smart contracts are self-executing pieces of code that live on the blockchain. They allow users to exchange value in a trustless way by automatically executing when certain conditions are met. For example, you could create a contract that pays out every month based on the price of Ether (ETH) relative to USD.

Decentralized exchanges (DEXs) offer a more secure and censorship-resistant way to trade cryptocurrencies, and they are starting to gain popularity among traders.

Unlike centralized exchanges controlled by a single entity, DEXs are decentralized networks that allow users to trade cryptocurrencies directly with each other. This eliminates the need for a third party to hold user funds, making DEXs more secure and censorship-resistant.

Tokenized assets are digital representations of traditional asset classes like stocks, bonds, and commodities. They are created on blockchain platforms and traded on decentralized exchanges.

On-chain & Off-chain Mechanics

The mechanics of blockchains are what allows them to be decentralized. Transactions and data are verified by nodes in the network rather than a central authority.

This also allows for trustless transactions, meaning that no one party is responsible for verifying the legitimacy of a transaction.

Instead, this verification is done through consensus among the nodes in the network.

Here are the two main types of mechanics: on-chain and off-chain.

On-chain mechanics are handled by the blockchain itself, while a third party handles off-chain mechanics. There are pros and cons to both on-chain and off-chain mechanics.

On-chain mechanics are more secure because the blockchain itself handles them. This means there is no chance of someone tampering with the transaction or stealing your funds. However, on-chain mechanics can be slow and expensive because every transaction needs to be verified by the miners.

Off-chain mechanics are faster and cheaper than on-chain mechanics, but they are less secure because the blockchain does not handle them. This means a greater chance of someone tampering with or stealing your funds.

What are some applications of DeFi?

A new wave of decentralized finance applications is emerging to build a more equitable and efficient financial system. While still in its early days, several promising projects are worth keeping an eye on.

One key trend is the use of blockchain technology to create decentralized exchanges (DEXs). These exchanges allow users to trade tokens without relying on a third party. This can help reduce fees and improve security.

Another important trend is the development of decentralized lending platforms. These platforms allow borrowers and lenders to connect directly, without the need for a middleman. This can help reduce costs and provide more flexibility for borrowers.

Decentralized finance applications have the potential to revolutionize the financial system by providing more transparency and efficiency. Of course, it is still early days, but these projects are worth watching closely as they continue to develop.

Types of DeFi

There are many different types of decentralized finance, or "DeFi," for short. Some of the most popular include decentralized exchanges, stablecoins, and lending platforms.

1) Decentralized exchanges (DEXs): These platforms allow users to trade cryptocurrencies and other digital assets without a third party. This is done by using smart contracts to match buyers and sellers automatically.

2) Stablecoins: digital tokens designed to maintain a stable value. This is done by pegging them to a stable asset like the US dollar or gold.

3) Lending platforms: allow users to borrow and lend cryptocurrencies in a peer-to-peer fashion. This can be used to earn interest on your holdings or access capital without selling your cryptocurrency. Loans can be taken out in any currency and are often used to increase liquidity or advantage arbitrage opportunities.

4) Derivatives: are securities that derive their value from an underlying asset or group of assets. They can be traded on decentralized exchanges and can be used to hedge risk. There are various types of derivatives, including options, futures, swaps, and forwards.

Derivatives can achieve various goals, including diversifying investment portfolios, hedging against risk, and speculating on price movements.

5) Crowdfunding: decentralized finance allows individuals and organizations to raise funds from many people. Crowdfunding can take many forms, including donation-based crowdfunding, equity crowdfunding, and debt crowdfunding.

6) Payment processors: These platforms allow users to send and receive payments in various cryptocurrencies.

Finally, there are decentralized asset management platforms. These platforms allow users to invest in various assets without trusting a third party. This can be helpful for things like hedging or diversifying your portfolio.

Advantages of DeFi over CeFi

The decentralized finance (DeFi) movement is growing rapidly as more people become aware of its advantages over traditional financial systems. Here are some of the key benefits of DeFi:

1. Decentralized systems are more secure than traditional financial systems because they are not centrally controlled. This makes them less vulnerable to hacks and other attacks.

2. Decentralized systems are more democratic than traditional financial systems because they allow anyone to participate without a centralized authority.

3. Decentralized systems are more efficient than traditional financial systems because they do not rely on a central authority to manage transactions. This leads to faster and cheaper transactions.

4. Decentralized systems are more transparent than traditional financial systems because all transactions are recorded on a public ledger that anyone can access.

What's next for DeFi?

The decentralized finance (DeFi) movement is growing fast. But what's next for the space?  There are a few key areas where DeFi could see further development.

DeFi market size, by segment 2022 | Statista

One is in scalability, as current platforms can only handle a limited number of transactions per second. Another area is interoperability, or the ability to move money and assets between different platforms. 

DeFi also faces regulatory uncertainty, as governments are still trying to figure out how to deal with this new form of finance. This uncertainty could hold back innovation in the sector.

DeFi Trends in 2022: Growing Interest

Finally, DeFi still needs better user experiences if it's going to reach mainstream users. Many people find the technology too complex and challenging to use.

Final Thought

Finance has been around for centuries, and over that time, it has become a more complex and sophisticated industry. Today, there are various ways to manage money, and one of the most popular methods is through decentralized finance or “defi.”

In the coming years, decentralized finance (DeFi) will change our lives in ways we can’t even imagine. DeFi is an umbrella term for financial applications that run on a blockchain or distributed ledger technology.

There are already a number of DeFi applications in use today, and many more are in development. One of the most popular DeFi applications is Ethereum's "MakerDAO" protocol, allowing users to create stablecoins pegged to the US dollar.

Due to these benefits, defi products have seen rapid growth. This makes it important for investors to keep an eye on defi as it grows in popularity.

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