What is DeFi? A Singaporean’s Guide to Decentralized Finance

One of the crypto buzzwords of 2021 is “DeFi”. Sounds like an underground resistance movement, but it’s actually short for decentralized finance, i.e. an alternative version of the traditional financial system.

As a sneak peek into DeFi really be the future of our financial system? Hard to say at this point, but it’s definitely interesting to think about. Here’s what you need to know about decentralized finance.

What is DeFi?

DeFi is not a call to DeFy the powers that be. It actually stands for Decentralized Finance.

More specifically, DeFi is a movement that promotes the decentralization of the financial system, and allows investors to bypass the authorities and middlemen like banks and insurers, transacting amongst themselves.

In order to facilitate such transactions, DeFi relies heavily on blockchain technology and cryptocurrency. If someone is trading on the DeFi market, they’re probably doing so with crypto.

One of the draws of DeFi is being able to bypass the traditional institutions that control the financial system, like governments and banks. Instead of your transactions being tracked by a bank or broker, they are recorded using encrypted code in decentralized public accounts to which all users have access.

Since all users have access to the publicly-available accounts and can see proof of ownership and transactions, this cuts out the need for a “middleman” like a bank to manage the system or take a cut of the profits. It also supposedly offers greater transparency and security, since there are no worries that the middleman will hide certain information or get hacked.

Comparison of DeFi vs traditional finance

The conventional financial system as we know it is highly centralized. Governments and authorities (like our own MAS) are heavily involved in regulating every aspect of the system.

As customers, there is no way to bypass this. For instance, if you want to get a home loan, you head to a bank, which functions as a sort of middleman. The bank itself is regulated by the authorities and needs to abide by rules like the TDSR when lending you money. The same goes for stock trading—you need to go through a broker and trade on an exchange, both of which function as middlemen that are regulated by the authorities.

One of the issues with having to go through middlemen is their existence hinges on being able to profit from your transactions. When you’re trading stocks, the broker collects a commission. When you put your money in a savings account, the bank lends your money to another customer at a higher interest rate than what they’re paying you.

Another selling point of DeFi is that it can be an avenue for people who don’t thrive in the traditional financial system. For instance, access to banking and financial services is not equal, with the rich having greater access to loans and trading opportunities.

Governments and centralized authorities also have a lot of power, and can block market access or access to funds. So, if you’re a mafia boss, the appeal of an unregulated, decentralized market is clear.

What can you do with DeFi?

At the moment, the two main cryptocurrencies being transacted in the DeFi universe are Bitcoin and Ethereum, using decentralized apps known as dApps.

dApps can do just about anything under the sun, but they lend themselves easily to financial transactions in particular. Here are a few things dApps can let you do without the need for a bank, brokerage or central authority:

Transact – This includes making payments, trading, lending, borrowing and getting insured. There’s a DeFi version for each of these activities now. For instance, you can borrow or lend funds through a peer-to-peer model, or buy insurance through a DeFi insurer to protect your assets in case you lose your password or get hacked.

Trade on an exchange – Although you can trade cryptocurrencies through conventional (ie. exchanges, there are also Decentralised Exchanges (DEXs) like Uniswap and SushiSwap which let you perform peer-to-peer transactions, ie. buy from or sell to directly to other users.

Use e-wallets – Cryptocurrency e-wallets like Trezor and Exodus let you store your bitcoins, orgnaise your various private keys and give you an added layer of security from hackers and viruses.

What are the risks in DeFi?

Part of the appeal of DeFi is the lack of regulation. But institutions like the MAS aren’t necessarily the Big Bad Wolf — they actually put in place safeguards to protect consumers and to a certain extent prevent them from being exploited by middlemen like banks and insurers. For instance, up to $75,000 of your deposits in banks in Singapore are insured.

Because of the lack of regulation, the DeFi markets can be very unpredictable and volatile. While it doesn’t happen often, cryptocurrencies can crash overnight due to panic selling.

The DeFi space is also not immune to theft and fraud. Hackers can steal crypto assets from under your nose, and crypto scams are not uncommon.

From January to April 2021, crypto criminals stole 432 million USD globally, with 56% of this amount being related to DeFi. And analysts think that cryptocriminals are going to be targeting DeFi more and more in hopes of exploiting security lapses in new projects and inexperienced users.

As a user, you should do your due diligence before you decide to throw your money into any DeFi application or protocol. It’s best to stick to the more established ones as there is a greater assurance of security.

When assessing an application, you should also check if the code is being shared publicly and peruse online forums to see if other people have raised concerns about security.

Key takeaways for Singapore investors

DeFi is an interesting proposition, but due to the lack of regulation it’s also very risky for the average joe who doesn’t have a mountain of cash to throw into the abyss, never to see it again.

If you really want to tempt fate, however, you can invest in the more popular DeFi-related crypto tokens like Ethereum on a crypto exchange. Just bear in mind the risks and only trade what you can afford to lose.

Do also note that MAS is actively monitoring the crypto sector; for example, by issuing a warning to crypto exchange Binance International for operating without a license.

That said, apart from trying to warn the public of the risks, MAS has not stepped in to ban or restrict crypto trading. That’s mainly because the volume of crypto trades in Singapore is still very small. If everyone starts dumping all their cash into crypto, don’t be surprised if MAS later changes their tune.

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