Devolved funding, nicknamed DeFi, is a trend in the crypto field gaining steam and showing promise, though credible doubts remain. Devolved funding depends on two main principles:
- Devolution, provided by blockchain technology
- Non-addictive products, which means there is no middleman between the consumer and the financial product being used, only protocol
With these founding principles set out, what in devolved funding? What are its advantages and disadvantages, and how is it viewed through the eyes of regulators?
What, Exactly, Is Devolved Finance?
Applying the term “devolved funding” can be a simple but effective starting point for explaining the emerging phenomenon.
Let’s start with funding.
According to Investopedia, the nominal funding refers to “issues relating to the management, creation, and study of money and investments ”. For DeFi’s discussion, managing and creating money and investments may be the most relevant features of this definition.
The Corporate Finance Institute (CFI) provides specific examples of finance, including “investing, borrowing, borrowing, budgeting, saving and forecasting”. In general, borrowing, investing, forecasting and borrowing may be the most relevant of these examples in terms of devolved funding.
And what about DeFi’s “decentralized” approach?
Merriam-Webster provides two definitions of “devolution”:
- delegating power from central authority to regional and local authorities
- the dispersal or distribution of functions and powers
All of these definitions apply to devolved funding. Collectively, devolved funding appears to be concerned with finance related activities such as borrowing, borrowing, investing and forecasting through non-centralized authority mechanisms, rather than control over a financial system (to the extent which control) is dispersed.
From a 1,000-foot view, this is an accurate depiction of DeFi’s core holdings. Now to get a little more specific …
Decentralized finance includes financial platforms and services that blockchain technology builds on and powers. These services vary in purpose and specificity, but can generally allow consumers to borrow or borrow cryptocurrency, buy and sell coins, speculate on the future value of goods, and buy or sell token assets.
Like other developments in the finance sector over the years, devolved funding is a new way of engaging in the economic activities that facilitate the making (or loss, if you’re unlucky) of money. The main draw factor is that instead of asking for a middle man / organization, it is the users who control the mechanisms that facilitate their transactions (in theory at least).
What Allows DeFi to Work?
In short, blockchain technology and specific protocols allow decentralized finance to function. Under these two essential elements is the internet, without which blockchain technology would not be possible.
One definition of protocol in “a set of rules or procedures governing the transfer of data between two or more electronic devices ”. When protocols exist on a blockchain, a network of computers, called nodes, maintains specific protocols. These protocols govern the features of blockchain such as:
- The algorithmic mechanisms with which nodes communicate
- The method of approving transactions within the blockchain
- How new nodes are received to the blockchain
These protocols generally undermine blockchain, and thus enable decentralized financial products. The specific limits on which DeFi application founders use these protocols determine what each product can do for its users.
What are the Benefits of Devolved Funding?
The benefits of devolved funding vary from one general DeFi category to the next, and even one application to another.
But, in general, the benefits of devolved funding lie mainly in devolution as a principle. Without devolution, DeFi’s benefits are becoming much less obvious.
Central financial institutions must be thought of as flawed in many ways, including but not limited to:
- Lack of control over how the system works by those who support the system (the financial user)
- Lack of transparency in how decisions affecting the financial system are made
- Lack of control and transparency in the treatment of your specific deposits
- The potential that arbitrary or honest decisions by financial institutions or regulatory bodies could put your deposits at risk
DeFi supporters aim to flip these flaws on their heads. Their goal: to use central financial institutions’ consent– Devolved financial products—as the selling point of their DeFi products.
In an ideal devolved financial system, the benefits would include:
- Democratic control by participants (financial users) over how a system works
- No central authority with external power to affect the fate of participants’ deposits
- An internet connected mobile device is a greater reach for customers regardless of geographical location, so that everyone would theoretically need to participate
- Reduced vulnerability to external breaches due to decentralized security protocols
- Greater autonomy to democratically modify certain blockchain protocols, which could allow dynamic shifting of interest rates for cryptocurrency lending as one potential benefit
Reliability is a key benefit for DeFi, as deals are ratified by smart contracts that govern the exchange of coins. Instead of just having faith that a bank will offer your assets (which they have borrowed in the meantime) when you ask for them, smart contracts guarantee that your coins will be delivered when defined conditions apply hand are met.
Keep in mind that these ideals decentralized finance, and time will tell how far DeFi products in the real world meet these gold standards.
What is the State of DeFi Today?
Currently, decentralized finance is virtually synonymous with the Ethereum (ETH) blockchain, known for its interoperability and easy-to-use interface. DeFi pulse sets out how existing, Ethereum-based products in the DeFi space offer:
- Cryptocurrency lending and lending
- Devolved exchanges for buying cryptocurrency
- Ability to bet on fluctuations in the value of assets by purchasing synthetic derivatives
- Peer payment services
- Tokenized asset management
You can see DeFi’s extensive list of products, including industry lending leaders like Aave, Maker, and Compound here.
It is fair to note that, according to the middle man (traditional financial institutions), decentralized funding reflects the slate of non-devolved financial products. Another difference between DeFi and more traditional financial products is the relative youth of the devolved finance sector, which continues to evolve rapidly.
How Do Regulators See DeFi?
There seems to be a scare on the horizon that regulators will come for DeFi products, sooner or later. Just like the Security and Exchange Commission (SEC) eventually cracked down on ICOs in the name of curbing digital fraud, some have gone so far as to state that “Regulators are circling” the DeFi sector.
As with any regulatory issue, speculation and openness will govern under regulators—The SEC or otherwise – move openly. Calls for self-regulation as a way to shut out regulation, if history is any indicator, can range from naive to overly optimistic.
The finding that the creators of DeFi products do not spawn truly decentralized products, but for their own personal benefit, certainly does not help the cause of those hoping to censure outside regulation.