Why is DeFi Important?
DeFi - December 12, 2020
Decentralized Finance or DeFi was about creating a solution to the money problem. But before understanding what these DeFi solutions are we need to understand why DeFi is important?
There’s no one best use of money,’ but there are several ‘efficient’ uses of money. Decentralized finance (DeFi) is allowing us to tap into these efficient uses. Its underlying technology, distributed ledger technology is the key to this efficiency.
Cash is the foundation of finance, and it’s the most inefficient. A pile of cash stuffed under a mattress will only lose value. Plus, cash has no ownership, it can be stolen and used instantly. How can cash be made efficient? It can either be used to purchase something, or it can be stored.
A bank account is required to store cash. But a bank account cannot make cash very efficient because it gives an insignificant return. However, beyond the minimal return, a bank creates efficiency of interaction. You can now use electronic payments on the internet, write a cheque, and use the facilities of bank accounts and debit cards. This creates some efficiency, but not much.
The next step of efficiency is investing. The point of investing is to give inefficient money to someone who can make it efficient. This could be a company that runs a manufacturing business. It knows where to source the raw-materials, how to manage the supply-chain, and finally what to build. But such a company does not have the money on hand to do all of this. Investing could give them that boost. Such a company could turn inefficient money into efficient money.
Turning inefficient money into efficient money is how an individual, a company and a country become wealthy. However, the gap between the two requires a lot of trust. Giving your money to someone who can use it better than you can and grow it for you requires a lot of trust. This trust is layered with a lot of fees and friction. Fees in terms of the intermediaries which take inefficient money and make it efficient and the friction of the entire process.
The fees and friction were a necessity, but they are slowly being replaced. Earlier, large banks were essential in making money efficient. They would take inefficient money, store it and invest it in companies which could make it efficient. However, because of this intermediary service, they charged fees and caused friction. Now, technology is replacing banks in turning inefficient money into efficient money.
DeFi is providing technology to create efficient money. Through DeFi’s distributed ledger technology and its features of transparency, immutability and scalability, companies that can turn inefficient to efficient money are identified. Investing in these companies is easier through DeFi.
In addition to this, DeFi is allowing users to build tools to increase trust and decrease risk. Things like transparent loans, insurance contracts, pooled investments and more allow not just turning inefficient money into efficient money, but does so in a safe way. That is why DeFi is important.
Enjoy the video!