Core Series III: Decentralized Finance

How does a decentralized finance model change things for the average consumer?

In decentralized finance, we rely on code, or more specifically, smart contracts, to play the role of the intermediary in our financial transactions. This helps to mitigate the problematic human element that comes with the money middlemen referenced in Traditional Finance

In the decentralized finance model, consumers are given direct access not only to their funds, thanks to self-custody, but also transparency on how those funds are being utilized. 

For users in traditional finance, money placed into a bank account is largely done so on faith with the belief that it will earn them a return. The discussion around how that return is achieved is shrouded in obfuscation and mystery – not least because any returns that are being made will want to be protected from dilution.

If a financial strategy is disclosed, it may return less as a result, as others crowd the action or trade in an attempt to get similar returns. 

In complete contrast, users in decentralized finance are accustomed to viewing what their assets are doing, live, at all times. They can do this either by reading the smart contracts themselves, checking transaction histories on the blockchain itself, or through intuitive user interfaces that synthesize complex data into a more user-friendly wrapper. 

Trust in people is replaced with trust in code. 

However, this level of transparency comes with an intrinsic problem; whilst everything is freely available in the form of code, some barriers to entry will be insurmountable for the average consumer – namely the lack of accompanying educational content. 

This problem is managed in traditional finance by treating individuals as if they do not have the capacity to understand what is happening with their assets and therefore they do not disclose any of the actions they take to their users. Decentralized finance does not have this luxury. 

Additionally, as there are no central authorities policing DeFi (by definition), mistakes, malicious code and bad actors are all real, pragmatic concerns. Users are expected to “DYOR” (do your own research); to be constantly aware and prudent in their decision making whilst using DeFi. This means a tremendous information burden is placed on the user, the price of freedom.

Fundamentally, traditional finance and decentralized finance can be contrasted in particular using the established dichotomy of security and freedom. Whilst not a perfect comparison tool, as traditional finance can be insecure, for example, it is a helpful lens through which to perceive the two.

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