Decentralized Finance: An Emerging Alternative

The global financial system has created massive wealth, but its centralized nature means the spoils have gone to the people who are best connected to the financial centers of the world.

As global inequality continues to rise, how can wealth building tools become more accessible to the rest of the global population?

Luckily, technological developments and their rapid adoption make this the right time for a new decentralized financial system to emerge:

• The Internet: 3.9 billion users by the end of 2018
• The proliferation of smartphones: Two-thirds of the unbanked have mobile phones
• Digital banking: over 2 billion users by end of 2018
• Bitcoin and Blockchain: the emergence of new public blockchains

Today’s infographic comes to us from investment app Abra, and it highlights how public blockchains could help to enable a decentralized finance system.

What is Decentralized Finance?

Decentralized finance describes a new decentralized financial system that is built on public blockchains like Bitcoin and Ethereum. After all, Bitcoin and Ethereum aren’t just digital currencies — they’re foundational open source networks that could be used to change how the global economy works.

There are six primary features that differentiate public blockchains from the private networks used by governments and traditional financial institutions:

• Permissionless: Anyone in the world can connect to the network
• Decentralized: Records are kept simultaneously across thousands of computers
• Trustless: A central party isn’t required to ensure transactions are valid
• Transparent: All transactions are publicly auditable
• Censorship Resistant: A central party cannot invalidate user transactions
• Programmable: Developers can program business logic into low-cost financial services

In such a financial system, users will have access to apps that use public blockchains to participate in new open global markets – but how would this shape the global financial system for the better?

The Potential Impact of Decentralized Finance

Here are five ways that decentralized finance will have an impact on the world:

1. Wider Global Access to Financial Services

With decentralized finance, anyone with an internet connection and a smartphone could access financial services. There are a variety of barriers that prevent access in the current system:

• Status: Lack of citizenship, documentation, credentials, etc.
• Wealth: High entry-level funds required to access financial services
• Location: Vast distance from functioning economies and financial service providers

In a decentralized financial system, a top trader at a financial firm would have the same level of access as a farmer in a remote region of India.

2. Affordable Cross-Border Payments

Decentralized finance removes costly intermediaries to make remittance services more affordable for the global population.

In the current system, it’s prohibitively expensive for people to send money across borders: the average global remittance fee is 7%. Through decentralized financial services, remittance fees could be below 3%.

3. Improved Privacy and Security

In decentralized finance, users have custody of their wealth and can transact securely without validation from a central party. Meanwhile, in the current system, custodial institutions put people’s wealth and information at risk if they fail to secure it.

4. Censorship-Resistant Transactions

In a decentralized financial system, transactions are immutable and blockchains can’t be shut off by central institutions like governments, central banks, or big corporations.

In places with poor governance and authoritarianism, users can divest to the decentralized financial system to protect their wealth. For example, Venezuelans are already adopting Bitcoin to protect their wealth from government manipulation and hyperinflation.

5. Simple Use

Plug and play apps will allow people to intuitively use decentralized financial services without the complexity of the centralized system.

With a decentralized system, a woman in the Philippines could receive a loan from the U.S., invest in a business in Colombia, and then pay off her debt and purchase a home – all through interoperable apps.

The Potential Blue Sky

Unless governments and central banks suddenly cease to exist, it’s difficult to imagine a world where decentralized finance completely replaces their centralized counterparts.

But what if they can co-exist?

Public blockchains can interact with the traditional financial system to create a new hybrid model:

• Users could conduct economic activity on public blockchains and exchange their new wealth into the centralized system.
• Users could hedge against systemic risk by diversifying their wealth holdings in both the central and decentralized system.

Like the internet with knowledge, decentralized finance could help democratize the financial system.

But will we allow it?

How Boundaries Can Help the Blockchain to Scale

The blockchain offers a long overdue upgrade for our changing economy.

However, the world isn’t quite ready for broadscale blockchain adoption. The technology is still in its relative infancy, and to reach its true potential the blockchain must be able to successfully replace existing systems while also operating at meaningful scale.

Today’s infographic comes to us from eXeBlock Technology, and it explores how good blockchain governance can help solve the pressing challenges around blockchain adoption and implementation, including the ever-present issue of scalability.

So You Say You Want A Blockchain

While it’s relatively easy to implement a blockchain in an organization, it’s far more difficult to decide just how that network should operate. For a blockchain to generate and hold any real competitive advantage, there are a few key questions to consider:

Scalability
How big can you grow before sacrificing efficiency? As the blockchain grows, so do the number of nodes to process transactions. This creates a bottleneck and slows down the system.

Privacy
What are your privacy needs? The attraction of the blockchain lies in its ability to decentralize information and make it transparent, but this creates a challenge for corporations who use the blockchain to handle sensitive or proprietary information.

Interoperability
Will your blockchain play nicely with other blockchains? There are a number of blockchain configurations – and to date, no cross-industry standards. This means your blockchain might not collaborate smoothly with another blockchain, particularly if the security standards are mismatched.

How Can Blockchain Governance Help?

Blockchain governance is concerned with solving these problems by:

• Reducing scalability obstacles by finding ways for blockchains to reach consensus faster without sacrificing decentralization
• Providing a foundation for shared standards, so organizations can collaborate without risking the privacy of their data
• Providing a framework for adaptability – a playbook for the blockchain to rely on when inevitable problems and security issues crop up

Think of governance as a constitution to help the blockchain run smoothly: it improves efficiency, encourages collaboration, and outlines a course of action when the system falters.

Types of Blockchains

There are four different types of blockchains, each with unique characteristics:

Federated

• Operates under the leadership of a group, and access is limited to only members of the group
• Due to limited membership, they are faster, can scale higher, and offer more transaction privacy

Permissioned/private

• Access might be public or restricted, but only a few users are given permission to view and verify transactions
• Ideal for database management or auditing services, where data privacy is an issue
• Compliance can be automated, as the organization has control over the code

Permissionless/public

• Open-source and available to the public
• Transactions are transparent to anyone on the network with a block viewer, but anonymous.
• The ultimate democracy – this fully distributed ledger disrupts current business models by removing the middleman
• Minimal costs involved: no need to maintain servers or system admins

Hybrid

• A public blockchain, which hosts a private network with restricted participation
• The private network generates blocks of hashed data stored on the public blockchain, but without sacrificing data privacy
• Flexible control over what data is kept private and what is shared on the public ledger
• Hybrid blockchains offer the benefits of decentralisation and scalability, without requiring consensus from every single node on the network

Within each of these systems, blockchain governance outlines different standards for privacy and security. Governance determines how consensus is reached, and how many nodes are required. It establishes who has access to what information, and how that data is encrypted. Governance sets up the foundations for blockchains to scale according to the needs of the organization.

Blockchain governance exists to smooth the transition to widespread adoption, providing organizations with dynamic solutions to make their blockchain suit their needs without sacrificing the security of decentralization.