The Cryptocurrency Informer
What in the world is DeFi?
Today’s episode will cover events happening the week ending September 11th, 2020. This week we’ll be talking about DeFi: An explanation of DeFi and a couple of compelling DeFi -related stories of the week, including a protocol bug that made a minimum wage worker a lot richer, and a major exchange ‘s attempt to compete with yield farming.
More information on each of these topics can be found below.
September 11th, 2020: What in the world is DeFi?
(00:27) This week we’ll be talking about DeFi: An explanation of DeFi and a couple of compelling DeFi -related stories of the week, including a protocol bug that made a minimum wage worker a lot richer, and a major exchange ‘s attempt to compete with yield farming.
DeFi, or decentralized finance, is all the hype lately. The concept of decentralized finance is really at the core of cryptocurrency itself, but as traditional cryptocurrencies and blockchains became more adopted by the mainstream, they also became more regulated and centralized. This is arguably the nature of adoption – and by arguably, you can be sure there are crypto enthusiasts who will die on the hill of anti-centralization in cryptocurrency. So what is DeFi? Here’s a TLDR courtesy of a Coinbase blog post – and yes, the irony of utilizing a centralized exchange to explain decentralized finance is not lost here:
“Cryptocurrency’s promise is to make money and payments universally accessible– to anyone, no matter where they are in the world. (DeFi)…takes that promise a step further. Imagine a global, open alternative to every financial service you use today — savings, loans, trading, insurance and more — accessible to anyone in the world with a smartphone and internet connection.”
By using Decentralized Apps, aka “DAPPS” aka “D-apps”, smart contracts can be formed to essentially remove the centralized middlemen and custodians that are a part of traditional finance and traditional cryptocurrency exchange platforms.
“At their core, the operations of these businesses are not managed by an institution and its employees — instead the rules are written in [smart contracts]. Once the smart contract is deployed to the blockchain, DeFi dapps can run themselves with little to no human intervention…The code is transparent on the blockchain for anyone to audit…Dapps are designed to be global from day one…anyone can create DeFi apps, and anyone can use them. Unlike finance today, there are no gatekeepers or accounts with lengthy forms.”
DeFi, then, clearly is a response to a traditional financial system that is notoriously exclusionary. It speaks to the core nature of cryptocurrency, which in its relatively short existence, has become more centralized, and arguably, more exclusionary. KYC, or “Know Your Customer”, an anti-money laundering implementation, for example, is the norm with centralized exchanges, whereas traditional DeFi and Dapps aren’t typically beholden to this implementation. However, as with traditional crypto, as DeFi rapidly becomes more and more mainstream, we will likely see an increase of regulations.
As an illustration of this point, Huobi, one of the largest cryptocurrency exchanges, has recently launched a crypto savings product to compete with the increasingly popular, and somewhat controversial, DeFi act of Yield Farming – according to Coindesk:
“Despite lucrative returns from yield farming, white-hot DeFi has been criticized for potential security risks as more investors are putting money into unaudited smart contracts controlled by sometimes unknown founders. Nonetheless, the Seychelles-based crypto exchange did not hide its eagerness to participate in the DeFi world. Just on Aug. 23, Huobi launched a new token listing platform Huobi Inno Hub for DeFi tokens trading.”
This brings to light the other end of the DeFi double edged sword, so to speak. The lack of centralization, lack of custodian, and ease of entry allows anyone to participate, create applications, create cryptocurrencies, etc. This also means that protocols can be bugged, scams can occur, and people can lose a lot of money fast if they don’t do their due diligence. For example, this week “An anonymous user managed to net a profit of $250k from a $200 outlay, due to a flaw in a DeFi protocol clone’s rebase code.”, according to CoinTelegraph. Certainly a bug that no one on the receiving end of would be too disappointed with!
These aren’t criticisms of the technology, nor are they specific to only DeFi – scams and mistakes happen in traditional finance as well. Generally, though, in traditional finance, it’s a lot easier to recover from – due to the existence of a centralized custodial force. For example, if someone steals my banking information, or if I buy some scam product, I can expect that my bank will amend the situation for me. Or, in the case of a mistaken windfall of wealth…a “bank error in your favor”…you can be sure that will be quickly rectified in traditional finance. In DeFi, no one is there to amend the situation for you – if you get scammed you get scammed, if a bug in the smart contract code gives you a windfall of wealth, no one is going to take it from you. That’s why the DeFi community encourages that people understand what they are doing before they get too heavily involved in something potentially volatile or risky financially.
Of course, DeFi is still in the early days. Crypto and blockchain tech in general are in their early days still, so DeFi is really in its infancy. We can expect to see a lot of early adopters of DeFI making a lot of money, and we’ll likely see a lot of people lose money as well. Dapps and smart contracts are certainly a powerful, adaptive, and necessary technology in this space – and they will undoubtedly change the financial landscape. As with cryptocurrency in general though, there are a far range of opinions on whether DeFi will be a net positive or a net negative for the worlds of crypto, blockchain, and finances. Personally – I’ll skew toward the positive side of things – but if you want to form an educated opinion of your own, check out some of the links included in today’s episode!
That’s it for this week’s episode of The Cryptocurrency Informer. Don’t forget – if you want to read more about each of these stories, go to talk.bitcoin.tax and click on The Cryptocurrency Informer link. Every episode is accompanied by a number of relevant links for each story, so you can do your own in-depth research on the topics that interest you.
Also, check out the interview we released this week with Trekk! Trekk shares his experience as a consultant and a consumer in the world of cryptocurrency – how psychology plays a role in increasing cryptocurrency adoption, and how over-marketing to early adopters can alienate them. Plus – what it means to be a “pro” in the world of crypto!
And early next week, we’ll be releasing a special round-table episode of The BitcoinTaxes Podcast where we’ll be talking to Alex Kugelman and Matt Metras, two cryptocurrency tax pros, about some of the recent on goings in the crypto tax space – including an update on the second round of IRS educational letters being sent out to many crypto traders.
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Have a great weekend everyone – stay informed and stay safe!
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