What's the connection with Web3 & Decentralized Finance? How do you connect Web3 & DeFi?
What are smart contracts? What are the benefits and risks of using DeFi?
As you’ve learned, Web3 is largely based on blockchain technology, which makes the internet more open and equitable. It has the potential to change who holds the reins of the Web, from single entities and companies to vast networks of people. Similarly, decentralized finance, or “DeFi,” aims to be Web3's version of a more fair and just financial system: one that’s built by the people, and automated in ways that doesn’t require oversight and control by banks and companies. DeFi is evolving finance towards new ways of thinking. Its structure creates new kinds of value and uses for currencies that have not been part of the traditional financial system, nor were possible within it.
One way this is carried out is through the use of smart contract protocols. Smart contracts are just code, or programs, that are stored on a blockchain and run when certain, predetermined, conditions are met. These protocols make assets in DeFi more seamlessly accessible than those in traditional financial systems, by removing the middlemen, or intermediaries, like your banks and tellers. Smart contracts automate the process of putting an agreement into action. This ensures everyone involved can know right away what will happen as a result of the transaction: there is no need to wait for an intermediary or risk the loss of time, money, or other assets. You can trade and transfer your assets immediately, when and wherever you want. In DeFi, there’s no need to be in a specific location, waiting for banks to open or holidays to pass!
The majority of smart contract protocols to date have been built on Ethereum: a blockchain platform that was specifically created for hosting these smart contracts. Now, there are other blockchains they can be built on as well. The landscape of DeFi is constantly changing as developers look for solutions to problems. Protocols are constantly competing to provide the best possible technologies in the Web3 world.
When people talk about Web3, they often talk about cryptocurrency, hand-in-hand. This is absolutely because cryptocurrency is a fundamental part of most Web3 protocols. In fact, it’s even possible to compensate users (in the form of cryptocurrencies) who help start, run, add to, or improve these protocols: since Web3 has somewhat common goals of making the internet more decentralized and secure, these protocols may offer payment for services like computing, bandwidth, storage, identification, hosting, and other online services that traditional cloud providers used to offer.
Decentralized finance, or "DeFi," is an aspect of Web3 that has been gaining rapid attention world-wide. There’s certainly an appeal to using blockchain for real-world financial transactions without intermediaries. In traditional finance, middlemen may be able to stop, block, or discriminate against transactions and financial services or the individuals who are trying to use them. This seems to have become increasingly publicized throughout 2022! However, big companies and venture capital (VC) firms are putting a lot of money into Web3 businesses and development, too. They are certainly looking to benefit from all aspects of Web3’s growth. Because of this, it's inevitable that some will be run by more centralized entities, and there will be different variations of how they use blockchain technology. Remember, not all protocols are created or governed equally!
Key terms
Blockchain: a shared digital record (ledger) of transactions of information, linked in a way that makes it nearly impossible to alter the transactions or harm the network, because they are maintained across a decentralized, peer-to-peer network of devices.
Cryptocurrency: a digital asset, or currency, that uses blockchain technology and is secured by advanced cryptography. The way these assets are built makes certain that cryptocurrency coins and tokens can't be spent twice (double-spent) and their ownership can be proven, even without a central authority, like a bank. The first cryptocurrency was Bitcoin, for which the blockchain was created.
Decentralized: when powers or authority are distributed so a network, or otherwise, is controlled by several entities, offices, or authorities instead of a single entity or source.
DeFi (Decentralized Finance): a more recently regarded financial system and technologies that use secure distributed ledgers, like those used by cryptocurrencies. Banks and other institutions no longer have direct control over money, financial products, and financial services because transactions are made directly between users with no intermediaries.
Smart contracts: code, or programs, that are stored on a blockchain and run when certain (predetermined) conditions are met. Smart contracts are used to automate the process of putting an agreement into action (like buying, selling, or exchanging assets) without intermediaries.
QUIZ - How did you do retaining this information?
- Which aspect of Web3 has gained the most attention worldwide?
- a. Banks accepting cryptocurrency
- b. Decentralized Identities
- c. Decentralized Finance
- d. Flipping JPEGs
- Which of the following makes Decentralized Finance (DeFi) appealing?
- a. Transactions cannot be discriminated against based on the user.
- b. Blockchain technology eliminates the double-spend problem.
- c. Assets are accessible by users without intermediaries.
- d. All of the above
- You could say DeFi aims to be…
- a. a new way for big banks to make money
- b. the complete end to traditional finance as we’ve known it.
- c. a more transparent and just financial system.
- d. completely developed by 2025.
- True or False: In traditional finance, intermediaries (like banks and tellers) may be able to stop, block, or discriminate against transactions and financial services, or the individuals who are trying to use them.
- a. True
- b. False
- What are smart contracts?
- a. Contracts, or code, that write themselves by using artificial intelligence
- b. Code, or programs, that are stored on a blockchain and run when certain, predetermined, conditions are met.
- c. A new technology in decentralized finance, that is not yet operational
- d. Agreements between developers and banks to help them transfer cryptocurrency
- Which blockchain was specifically created for hosting smart contracts?
- a. Bitcoin
- b. Ethereum
- c. Solana
- d. None of these
- True or False: All DeFi protocols are created and governed equally.
- a. True
- b. False
Answers:
1. c
2. d
3. c
4. a
5. b
6. b
7. b
