DeFi stands for Decentralized Finance and is the ideal of financial services operating autonomously with no concentration of power in any one commercial or political entity. All of the financial services that we expect from banks, governments, and corporations have an alter ego in the world of DeFi.
- Liquidity pools are the alter ego of order books.
- Staking is the alter ego of the interest received on bank deposits.
- Flash loans are an alternative to lines of credit.
DeFi developers are inventing and launching new decentralized financial products every week, as they rush to be at the forefront of this wave of innovation. Each new product has a complex set of requirements and challenges to overcome.
We saw a big breakthrough a few years ago when Vitalik Buterin introduced a concept that could replace the need for a centralized matching order book and engine to allow people to trade assets with each other.
A little background: an order book is a register (manual or electronic) of buy and sell orders for specific securities at specific price levels. Orders that are placed ahead of time (“resting orders) are written to the order book, and executable orders coming in (“market orders”) are matched to these resting orders. For years, the need for an order book created an obstacle to decentralization. Someone was needed to manage the order book and take responsibility for its integrity and fairness, and stock exchanges or online brokers took on that role along with the power and wealth that comes with controlling the flow of assets.
Vitalik proposed an alternative structure to the order book called a liquidity pool. The big advantage to a liquidity pool is that it doesn’t require external human management – in fact, it can be managed by a smart contract. A smart contract is like a software program – it is not a person and it doesn’t need anyone to enforce it. It just does what it was programmed to do without any help or interference.
It has taken time for the concept to turn into real products, but over the past six months we’ve seen an increase in apps that have turned this technology into accessible products. It is still very much a niche industry, though, since the knowledge required to participate is complex and there is a lack of documentation throughout the space.
What we need are apps that simplify the process for participating in DeFi, and make it accessible and understandable to everyone.