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April 18, 2021

THE COMMISSION GROUP, Inc

Business Management Consultant

Defi 101 – Decentralized Financing

8 min read
  • Blockchain Technology
  • Smart Contracts
  • The Major Players
  • Industries Impacted by Crypto Technology
  • How you can get started

Decentralized finance is a blockchain-based form of finance that does not rely on central financial intermediaries such as brokerages, exchanges, or banks to offer traditional financial instruments, and instead utilizes smart contracts on blockchains, the most common being Ethereum.

Instead it relies on smart contracts — legal contracts written in and enforced by software — on blockchains like Ethereum.

smart contract is an agreement between two people in the form of a computer code. They run on the blockchain, so they are stored on a public database and cannot be changed. The transactions that happen in a smart contract are processed by the blockchain, which means they can be sent automatically without a third party.

smart contract is an agreement between two people in the form of computer code.

Word Bank
What is a Smart Contract

A smart contract is an agreement between two people in the form of a computer code. They run on the blockchain, so they are stored on a public database and cannot be changed.

What is a Smart Contract 2

The Transactions that happen in a smart contract are processed by the blockchain and are sent automatically without a third party. Finally total autonomy and accountability.

What is a Smart Contract 3

Transactions only happen when the conditions in the agreement are met — no third party, so there are no issues with trust.

Yes, just how do smart contracts work, then?

To find the answer, let’s start by looking at how a smart contract can be used:

Let’s imagine that John wants to buy Mike’s house. This agreement is formed on the Ethereum blockchain using a smart contract. This smart contract contains an agreement between John and Mike.

In the simplest terms, the agreement will look like this: “WHEN John pays Mike 300 Ether, THEN John will receive ownership of the house”.

Once this smart contract agreement has been put into place, it cannot be changed — meaning John can feel safe to pay Mike 300 Ether for the house.

Without the use of a smart contract in this scenario, Mike and John would have to pay lots of fees to third-party companies. Including the bank, a lawyer, and a house broker.

This is the next level, right? No more commissions and no more delays to wait for a lawyer and broker to process the agreement! This is just one of many examples of how a smart contract can be used.

DeFi

This is where Decentralized Financing aka DeFi is going: Instead of proving creditworthiness to a bank to obtain a loan, customers can use cryptocurrency as collateral to borrow money through the set terms of a smart contract. Instead of all payments running on traditional rails such as the automated clearinghouse, some will happen through the buying and selling of cryptocurrencies. Instead of trading stocks on a stock market, people can buy and sell cryptocurrency on a blockchain. Smart contracts could automate supply chain finance, cutting middlemen such as auditors out of the process.

Decentralized finance is taking many of the roles that traditional banks fill, like credit, payments, custody, stored value, and onboarding to the financial system.

hybrid versions of decentralized finance have emerged that blend traditional banking with DeFi. This is sometimes called centralized finance or CeFi. One example is stablecoins, digital currencies that are always equal in value to a central bank currency such as the U.S. dollar and that have centralized issuers. Another example is Coinbase, which lets people buy cryptocurrency, stores it for them, and lends against it in a centralized manner. And ConsenSys hosts several Ethereum blockchain-based finance projects, including JPMorgan’s Quorum.

An alarm should be going off in the traditional bankers’ heads because DeFi represents a new level of competition as well as the greatest opportunities for banks since gold.

The typical cross-border payment goes through six different institutions: two central banks, two correspondents and an originator and a receiver bank.

“It’s very difficult to figure out where something got caught up in that process because there are six different institutions involved. You can’t have a straight-through process because there have so many intermediaries.

Experts are turning to stablecoins to smooth out this process. Stablecoin transaction volumes crossed the $1 trillion mark in 2020, according to The Block Research. Instead of having to go through those six [banks] to get their payments settled, they can actually get it within minutes in stablecoin form.

Pure decentralized, humanless finance.

Borrowers can securely apply for a loan and receive funding in a matter of minutes and even use digital currencies as collateral. In fact, Silvergate Bank offers bitcoin-collateralized loans on a homegrown distributed ledger it calls SEN (which stands for Silvergate Exchange Network) Leverage. Customers can obtain and repay loans 24 hours a day, 365 days a year. These trends will lead to the rise of the modern core software providers that can help banks offer services tied to application programming interfaces. The possibilities are endless for smart contracts. They are already being used for financial trades and services, insurance, credit authorization, legal processes, and even crowdfunding agreements (ICOs).

Industries impacted the most

Insurance

Reportedly, at least two insurance companies, Atlas Insurance in Malta and Axa in France, tested smart contracts in 2017. They had prototypes that compensated airline customers if their flights were delayed.

Let’s see an example:

John is about to fly from NYC to Los Angeles. He sends $5 worth of cryptocurrency to the Axa Insurance smart contract and provides his flight number. Axa sends $95 to the smart contract. So, there is $100 in the smart contract.

If John’s flight is on-time, Axa is sent $100 from the smart contract. But if the plane is late, $100 is sent to John from the smart contract. Everything is automatic.

This saves lots of time and money. It also means that John does not have to trust that AXA will pay him the agreed amount if his flight is late — he knows that if it is late, the smart contract will instantly send him his compensation ($100).

Health Care

Health systems will use smart contracts to record and safely transfer data.

We can already see examples of smart contracts being used in the medical industry by the likes of EncrypGen. This is an application that uses smart contracts to transfer patient data in a secure wayallowing no access from third parties.

This way, the patients are in control of their own data. If researchers want to use patient data, they must pay for it. Not only that, but the patient has to choose whether or not they want to sell it to them.

Governments

For governments, smart contracts running on the blockchain can make voting systems completely trustless and much more secure.

Applications like FollowMyVote use smart contracts and blockchain technology to protect votes from fraud. When the voting transaction is written to the blockchain, it cannot be changed. When the voting is over, the smart contract will send a token to an address that represents the winner of the vote.

This way, voting is always fair, meaning the winner is always correct.

Business Management

Businesses can benefit massively from smart contracts. Instead of paying staff to run payrolls, they can use smart contracts.

Businesses can just set up a smart contract that says WHEN the date is 28.03.18, the Business sends John 2 ETH. This means John will always be paid on time, and he will never be underpaid. The business benefits because it is all automated, saving them lots of time and money!

ICOs

If you want to start your own project that uses the blockchain, you can build your project on the Ethereum blockchain, as we saw earlier. However, you’re going to need some money!

How’re you going to get the money you need? Welcome to ICOs.

An ICO (Initial Coin Offering) is a crowdfunding system for new applications that use blockchain technology. You create a smart contract and a token for that smart contract. Let’s imagine you call your token ABC.

You want to raise $10,000,000 to start your project and build your application — let’s imagine that $10,000,000 is equal to 10,000 Ether. You decide you’re going to put 100,000 ABC tokens into the smart contract, and that each ABC token is going to be worth 0.1 Ether.

That way, if you sell all 100,000 ABC tokens, you will have the 10,000 Ether that you need, because of 100,000 x 0.1 = 10,000.

Now, in the smart contract, you will write something like: IF 0.1 ETH is sent to the smart contract, THEN the smart contract will send 1 ABC to the address that sends the 0.1 ETH. That way, the people contributing to the ICO always get the right amount of ABC token.

Remember! It’s crucial to keep your cryptocurrencies in secure wallets. The most recommended options are Ledger Nano SCoinbase and Trezor

Why would people want to buy the ABC token?

The two most common reasons people buy tokens from ICOs are:

  1. The token can be used on the application once it is built;
  2. The price of the token may increase when the project becomes more popular.

You can think of ICOs as a blockchain version of Kickstarter. The key difference is that it automates the whole crowd-sale process in a secure way.

How are Smart Contracts Created?

Smart contracts can be built on multiple blockchain platforms, including Ethereum and NEO. As Ethereum is the most popular choice for developers, I will tell you about Ethereum’s smart contracts.

Smart contracts are developed using Ethereum’s original coding language, called Solidity.

If you want to learn Solidity, you can try our Space Doggos interactive Solidity tutorial! It’s a fun and friendly way to learn Solidity. By following the steps in the course, you will create your own Solidity game!

It can reduce frauddelaysand the overall cost of many things.

In Conclusion: Be willing to accept change; be willing to learn.

Crypto tech is here to stay and it would behoove you to make “smart investments” as Floyd Mayweather says, and learn technology for your business and your family. It is my understanding that Blockchain and cryptocurrencies are the future of finance and although you may be in doubt it won’t change the realities. This is an amazing time to open your teachability index to a 10; to be willing to accept change; to be willing to learn!

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