A Quick Primer on Decentralized Finance (DeFi)

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When we trade stocks, bonds, commodities, derivatives and other financial instruments, we normally rely on markets. These markets in New York, Chicago, London, Tokyo, etc., have traditionally been run by humans — humans who need to take breaks on weekends and go home to their families and rest after working hours.

Billions (if not trillions) of dollars' worth of these instruments exchange hands daily. The really good ones can “front run” orders because of the speed of their networks in what the public now knows as “high-frequency trading.” These trades run so fast that sometimes profits are made in the span of microseconds.

But what is often still slow about these markets is the settlement and finality. Sure, you’ve sold your shares of your favorite tech company (or whatever company you want). However, the money from the sale of your shares arrives only a few days later. The industry refers to this as T plus (number of days). So if you get your funds three days later, you’ve experienced a T+3 settlement.

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That might work for many older generations, but crypto degens (degenerates) and many in Gen Z use something called decentralized finance, or DeFi for short.

What is DeFi?

DeFi, as opposed to traditional finance or TradFi, uses no humans in the loop. Instead, DeFi uses a blockchain, which often has thousands of servers around the world running identical trading software. These software are often referred to as “smart contracts.” These smart contracts pretty much do what the bank staff does when they process payments, but in a matter of seconds. The transaction records are synchronized and finalized across all DeFi blockchain servers globally in a few seconds.

Larry Fink, the CEO of BlackRock, has said the tokenization of stocks, bonds and other instruments is the next generation of securities. Many financial experts agree.

The reason DeFi is faster (basically T+0) is that everyone uses the same network. In the banking and financial services sectors, the current mode is to have their own in-house servers to keep track of who owns what. So if broker A wants to sell a stock, they have to upload that into the broker’s trading server. Similarly, when a buyer is interested, they send money, and the stock is sent to them or their broker custodies it on their behalf.

The key thing to remember here is that the ledgers are separate. Robinhood’s ledgers and T. Rowe Price’s ledgers are separate. The brokers have ledgers, the markets have ledgers, and updating the record to reflect who bought what for how much takes time — because these records are in different places.

However once stocks, bonds, commodities and other financial instruments have been tokenized, they would all run on one global network. Thus when you buy or sell a tokenized stock, the system gets updated as to who now owns what in a number of seconds. Transactions and transfers of ownership are updated and synchronized.

If a well-known personality gets married, the wedding is broadcast globally. Then because that transaction has been updated into all our brain “ledgers,” it becomes next to impossible to deny that the wedding took place. It’s the same with the blockchain. If all the blockchain ledger servers get updated to reflect that Bob paid Susan $100, then that is that.

DeFi is the future

DeFi has grown in popularity since 2020, and there are now many decentralized exchanges (DEXs), such as Uniswap. Each crypto token tries to have at least one that caters to it. Ethereum has several, Solana has several, Cardano has several and so forth.

The rationale for DeFi goes even deeper. In 2008, when Satoshi Nakamoto published the Bitcoin white paper, the objective was to create a system that does not rely on the need to trust third parties such as banks, stockbrokers and the like. Instead, what he wanted to do was to create a system of trading tokenized assets that did not need humans.

DeFi is not perfect. It still has some high-profile hacks, and its user-friendliness leaves much to be desired. However, there are enough people around the world who want the freedom of trading with whomever they want.

It appears that financial services are slowly moving in that direction. If we try to go against it, we run the risk of getting run over.

Disclaimer

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.