Properties of Decentralized Finance
Decentralized finance differs in several ways from centralized finance services. Therefore, we shed some light on the most distinctive properties of DeFi.
- Composability
- Decentralization
- Accessibility
- Without identity
- Transparency
Composability
Composability means the ability to combine single services to a more complex service.
You can think of each DeFi service as a building block that, together with other services, forms another service. Applications can reuse existing building blocks.
While this allows complex and new services, it also creates dependencies. If one building block fails, this could cause a big portion of the DeFi industry to collapse.
Decentralization
Decentralization is a crucial part of DeFi. But it is not always clear what decentralization exactly means. This term can refer to different things like code execution, transaction triggering, and governance. The code execution decentralization depends on the underlying blockchain. It means that the code of the smart contract is executed on many nodes. If a single node fails, it will not harm the network or the DeFi service. Transaction triggering refers to the decisions made by the smart contract. Who needs to contribute to a transaction that the respective DeFi service works. For example, in a decentralized exchange, price information from outside the blockchain might be necessary. This could require a data provider (blockchain oracle). Governance refers to the maintenance of the smart contract. Who is allowed to update it, who receives fees, and is there anybody who can shut down or exploit the smart contract?
All three areas come with costs. For executing a smart contract, transaction fees are charged. Data providers need to be paid too. And the same holds for any maintenance and development activity. Whether these costs exceed the cost of centralized financial services is difficult to say.
Accessibility
Accessibility defines who can use DeFi protocols. Basically, everybody can use them. But of course, it is possible to restrict access to certain groups.
DeFi services are available for people around the world. Thus, they are borderless. It is difficult to enforce KYC and AML measures, which can contradict local regulations and make such services illegal in some countries.
However, wide accessibility creates opportunities for countries, regions, and people with limited access to centralized financial services.
Without Identity
Closely related to accessibility is the missing need for identification when using DeFi services. This also enables machines or computer programs to take part in financial transactions.
Transparency
Transparency applies to both smart contract code and financial data. To gain trust, DeFi protocols have to disclose their source code. Since transaction data are public also the number of transactions, the financial equipment, and the financial status of a DeFi project are clearly visible to everyone.
