What Is DeFi And What Is Its Impact?

You may have already heard that one of the pillars of the future is decentralization. Technologies like blockchain have started to change the way we carry out transactions and track assets, for example, and they seem to be here to stay.

What is DeFi and what is its impact?

An acronym that arises in this context is DeFi, which stands for Decentralized Finance, and aims to also decentralize finance.

DeFis were created to facilitate financial processes between people, independently. (Source: Getty Images/Reproduction) 

Brokers and other financial service providers that operate in the DeFi model are usually created in open source. They are defended by developers and other people who believe in a decentralized financial universe, but still demand regulation in many countries.

The idea is that negotiations can be carried out independently of intermediaries, between users themselves. The popularization of cryptocurrencies is an example of the practical application of this concept.

To help you delve deeper into this subject, we have prepared this article. In it, you will check the following topics:

• What is DeFi? 
• Types of DeFi operations 
• Risks involving DeFi 
• What are the impacts of DeFi on the future of fintechs? 

What is DeFi?

The acronym can be defined as Decentralized Finance  or, in free translation, decentralized finance. In general, DeFis aim to facilitate financial procedures requested by one user for another user. This is the case with cryptocurrencies in general and loans using this type of electronic money.

Taking the same example, through DeFi it is possible to request a loan without an intermediary to do so. It is enough for the person to request it from the other person using cryptoactives.

For panto, in DeFi environments resources such as blockchain are employed. This technology consists of a mechanism for transacting encrypted data that works as a “record book” in which important information is “noted”.

This technology operates mainly to prevent fraud from occurring, as it is possible to track the procedures carried out.

Additionally, smart contracts are developed, which can be accessed by users via the Internet. These are self-executing digital protocols widely used by those who operate cryptocurrencies. 

There are several types of cryptocurrencies, such as bitcoin, and platforms based on DeFi technology in operation around the world. (Source: Getty Images/Reproduction) 

Types of operations via DeFi

And what financial services can be provided using this type of technology? Among the operations possible by DeFi protocols are:

• financial services using cryptocurrency wallets; 
• transfer of values; 
• creation of crowdfunding campaigns;
  
• access to stable and volatile currencies; 
• continuous payments; 
• loan management; 
• purchasing insurance.  

And the trend is for this type of resource to become even more popular, with the frequent development and use of Decentralized Applications (dApps). They operate through a peer-to-peer network, made between users’ servers.

The creation of the first dApps is attributed to bitcoin, in 2008. Other sources relate its creation to the Ethereum platform, in 2013. This type of application is based on open source, whose operation is done through tokens, like the platforms themselves in which cryptocurrencies are sold, bought or lent. 

Risks involving DeFi

The main disadvantage, however, is the lack of regulation in several parts of the world. Without a body to supervise such operations, there is, therefore, a risk that must be considered among users who carry out any type of financial service using this route. 

Additionally, there are other possible risks involved  for those who want to venture into a DeFi transaction:

• Cyber attacks to invade applications due to code flaws or bugs;
• Scams, as smart contracts can become vulnerable, making it important to hire a code auditing company to ensure their security;
• Volatile investments that can suffer sudden rises or falls, which constitutes a high-risk investment;
• Level of complexity of the system for users unfamiliar with topics such as DeFi and cryptocurrencies, who may invest in the wrong places because they do not know how to act within this logic.

A notable case of a cyber attack suffered by one of the DeFi organizations  that provides services of this nature happened to Curve Finance in July 2023. 

At the time, the company was the target of an attack that resulted in the loss of around 40 million dollars. The problem occurred due to the update of one of the programming languages ​​used in the development of the platform. 

Cyberattacks are one of the risks involving decentralized finance. (Source: Getty Images/Reproduction) 

What are the impacts of DeFi on the future of fintechs?

Obviously, such innovations will impact the future of finance and influence the way the financial market behaves.

For fintechs, this idea may not be completely unknown. Especially those that since the end of the second decade of the 2000s had been operating under the Open Banking or Open Finance model  .

In any case, movements like DeFi show that users are increasingly willing to understand financial dynamics  and create their own means of carrying out their transactions. The focus is, therefore, on autonomy and, apparently, this is not a temporary movement.

Taking the creation of bitcoin in 2008 as a starting point for the discussion, it can be seen that the idea of ​​carrying out finance in a decentralized way has already been in vogue for at least two decades. And, since then, other tokens, such as cryptocurrencies and trading platforms, have been created.

Regulation of cryptoactive transactions is already in force

One of the issues that, given the need created and frequent use by users, may arise at some point is regulation and , consequently, inspection. 

Even though the idea of ​​open source, autonomy and independence weighs on the concept of DeFi, in some instance and due to the existing risks the regulatory debate will weigh.

And, with regard to Brazil, a law has already been sanctioned: n  . 14,478, of December 21, 2022. Said legislation “provides for guidelines to be observed in the provision of virtual asset services and in the regulation of virtual asset service providers.” 

Therefore, in Brazil, any type of organization that acts as a provider of virtual services to carry out cryptoactive transactions will need to comply with the terms of the law, in force since the beginning of the second half of 2023.

The same law cites in its third article the definition for virtual assets: “the digital representation of value that can be negotiated or transferred by electronic means and used to make payments or for investment purposes, not included”, as is the case of electronic currencies.

One of the issues highlighted by the law and which comes into force is that of embezzlement, which updates the Penal Code, with imprisonment that can vary from four to eight years for anyone who obtains any type of illicit advantage in transactions involving virtual assets. 

In Brazil, there is already a law to regulate organizations that act as service providers for those who carry out some type of transaction involving cryptoassets. (Source: Getty Images/Reproduction)

Financial Education

Another market that is beginning to emerge in DeFi is financial education to deal with cryptoassets.

In September 2023, the Federal Revenue of Brazil released a piece of information that caught our attention: the number of Brazilian investors who carried out some type of transaction with cryptocurrencies during the year grew by 200% , which represented a jump from 794,755 to 1,336,715 users.

In other words, there is a growing number of people interested in carrying out decentralized financial transactions, which could increase even further.

And if the topic of what’s to come for fintechs interests you, we invite you to check out another article published on the Cubo blog: Future of fintechs: predictions for the coming years. In it, you will discover more about the trends in this market.

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