Open Finance on Bitcoin: Our Contribution to the Ecosystem
The exponential rise in the popularity of decentralized finance (DeFi) is not going unnoticed. This equitable approach to finance not only poses a threat to the orthodox financial mechanisms that have, for long, stalled equality and financial freedom for the masses but also helps level the field for individuals who might not have had easy access to essential financial services.
An increasing number of companies are foraying into this budding space and it won’t be long before it re-engineers the global financial fiber as we know it today. In this post, we deep dive into the world of DeFi and explore how RSK blockchain is doing its part in fostering a financial system for everyone.
Introduction
As of 2018, according to the World Bank, nearly 1.7 billion people around the world had no access to bank accounts—the global unbanked population, as we commonly know them. In a fast digitizing world, this is a major crisis. Among other things, this highlights the glaring fact that traditional finance systems have been highly exclusionary in terms of accessibility.
Over the past decade or so, these factors have played into the rapid growth of the fintech sector. Despite massive usage and innovations, however, fintech is not free from the vices of traditional finance, compelling some bright minds to ask: is there a way out?
Indeed there is and the answer is Decentralized Finance, commonly known as DeFi. In short, DeFi is the revolution in money that Bitcoin started in 2008. As opposed to the centralized systems of traditional finance, DeFi leverages blockchain technology to enable decentralized, peer-to-peer financial systems. Although still in its infancy, DeFi promises a complete transformation of the ways in which we conceive, create, own and use money. This post is meant to help with that, giving the reader a holistic overview of what the future of finance might look like.
Traditional or Centralized Finance (CeFi) and Its Problems
No matter how “seamless” on the surface, a lot goes on behind the scene of every monetary transaction. Immensely robust frameworks go into making payments or any other financial activity possible. Traditionally, centralized bodies (governments, banks and payment gateways to mention a few) both facilitate and control our financial transactions. As such, these systems are highly siloed and pose several other threats to the users which we will discuss in a while. First, let’s get a clearer picture of how CeFi works.
Broadly, there are two major aspects of money: creation and usage.
In CeFi, governments and central banks have absolute control over the creation of money. They standardize and sanction legal tenders, print banknotes and issue digital currencies. In terms of usage, fiat currencies have value only because we put our trust in the issuing centralized actors. This is the cornerstone of CeFi or fiat-based financial systems. Unlike gold or the likes, there’s no inherent value to fiat currencies. They are merely legal contracts based on trust and authority from central actors.
Now, imagine sending $10 to your friend. For this, you have to use some payment gateway which mediates the transfer of funds to your friend’s bank account from yours. The same principle applies when you make merchant payments or any other transaction, either digital or in cash. Intermediation is always required for making transactions possible. This over-centralization on CeFi raises pertinent concerns.
A Single Point of Error
When a system is controlled by a singular, centralized entity, its integrity depends on the integrity of this entity. That is, if the controlling body falters or is breached, the system collapses causing the users to bear massive losses.
Opacity and Lack of Users’ Control
When we deposit money in a bank, the latter lends the same at high rates of interest. In terms of how financial institutions use our money, we have little or no knowledge within CeFi, let alone control. This applies to almost every intermediary in the system, ranging from central banks to insurance providers to the local grocery store.
High Facilitation Costs
Not only does CeFi involve a massive infrastructure and the consequent overhead costs but it also entails fees and payments for the system’s many intermediaries. Combined, these add up to high facilitation costs which, of course, the user bears in most parts.
Inefficiencies and Limitations
Despite significant improvements being driven by fintech, CeFi at large remains cumbersome. Completing a trade in the stock market may take considerable time and so does sending payments abroad. When it comes to getting a loan or an insurance claim, the matter could take even weeks.
The Rise of DeFi
So much for understanding the problem. Now, with the structure, function, and limitations of CeFi as the backdrop, we are well-equipped to discuss the solution—Decentralized Finance. For many, it’s a financial revolution and there’s good reason to see it that way.
It began in 2008 when Bitcoin’s whitepaper was published. Bitcoin proved in many different ways that intermediation is not a requirement. In doing so, Bitcoin firmly established that finance, after all, could be decentralized and RSK expanded on Bitcoin’s capabilities by enabling smart contracts and consequently DeFi on top of Bitcoin’s network.
The Functioning of DeFi: How Is It Different From CeFi?
Also known as Open Financial Systems, DeFi platforms are decentralized and built on top of distributed ledger technologies (DLT), such as blockchain. Hence, at its core, DeFi has some of the essential functional elements of its underlying framework (although the framework itself is evolving).
Broadly, DeFi has two fundamental differences with its centralized counterpart:
- The network is decentralized and no central governing entity is required. Even when there is (as in the case of permissioned or consortium blockchains) their authority is limited only to certain aspects of the network. The existing DeFi systems have varying degrees of decentralization and a governance token enables token holders to define the governance mechanisms among many other things.
- Instead of the “trusted intermediaries” of CeFi, decentralized financial systems have cryptographically encrypted code blocks or smart contracts. In effect, this further rules out the need for overseers in the system as the rules/principles are encoded into its very structure.
With that being said, some relevant questions remain unanswered: What practical benefits does Defi offer over CeFi?
DeFi’s Advantages Over Centralized Finance
Automated Compliance
Instead of relying upon external entities to ensure compliance and vesting immense powers on them, DeFi systems are inherently compliant. Here, the rules are encoded into the transaction and automated. That is, a decentralized transaction cannot occur unless it is compliant to predetermined clauses (for instance: X, if and only if Y).
Transparency
By storing data on shared ledgers to which the network’s members have equal access, DeFi systems become fully transparent and auditable.
Global Access
Essentially, DeFi systems are location agnostic, enabling anyone with access to an internet-enabled mobile device to use these services.
In general, DeFi can indeed overcome all of the aforementioned shortcomings of CeFi, including high costs, long processing times, etc. All of today’s innovations in this field are, in fact, aimed at such holistic transformations in favor of users.
The DeFi Ecosystem
What are the toolkits that DeFi has to deliver on its promise? Indeed, that’s a valid question and we have positive answers, despite the technology still being in its infancy.
Smart Contracts
Smart contracts define the principles or rules of a decentralized financial transaction. Besides making transactions inherently valid, they also automate the process and eliminate the need for mediators.
Decentralized Applications (dApps)
Unless the front-end application which interacts with end-users is decentralized, the underlying DLT doesn’t make much sense. That is, to use a decentralized network, we also need decentralized applications or dApps. Unlike traditional applications, these apps are essentially interoperable smart contracts that store data on the underlying blockchain.
Decentralized Autonomous Organizations (DAOs)
Traditional finance is centralized because a centralized infrastructure supports it. Employees under managers under owners or directors: this is the hierarchy of almost every CeFi organization, wherein those at the top have supreme control and authority. On the contrary, DAOs are fully-functional organizations that decentralize their hierarchy and function using blockchain technology.
DeFi Entails Complete Financial Systems
In the context of DeFi ecosystems, we must realize how DeFi is different from fintech or what it entails as a whole. When we say open financial systems or decentralized financial systems, we mean complete ecosystems where the user can do everything with their money as in CeFi. This includes earning, spending, saving, borrowing, lending and trading.
DeFi for Bitcoin: RSK’s Approach to Decentralized Finance
Although new solutions are coming up almost every day and some of them have great potential, most of them are focused on Ethereum. RSK expanded the options by enabling DeFi on top of Bitcoin. At RSK our vision encompasses not only the future of DeFi but also of Bitcoin and that’s why we have combined both. Ever since the early days of DeFi, enthusiasts have been asking whether Bitcoin will ever join the DeFi revolution. DeFi platforms such as Money On Chain (MOC) and RIF are a testimony to the enormous potential of DeFi and how it is making finance more inclusive and easily accessible.
RSK Blockchain’s Vision for DeFi
In the tech world, we often come across the term “disruption” which is no doubt used in a positive sense. Yet, there’s a slight issue here, we feel. Unless we have mass adoption and the subsequent setting of standards based on popular usage, disruptions are rather meaningless. After all, what are we disrupting anyway? CeFi? Indeed. However, from a broader perspective, that’s not the only goal of the Open Finance movement. Our goal is not merely to uproot one system and replace it with another but rather build a future with the best of all that we have and can create. So, more than disrupting, our focus for Open Finance is on creating value so that it touches more lives, transforming them in the process.
An Inward-Looking Approach
Over time, we have realized that most of the existing DeFi solutions are extremely difficult from a non-tech user’s point of view and that’s why a large part of what we are doing today, is to make it as easy as possible to everyone.
The DeFi Ecosystem on RSK: The RIF On Chain (ROC) Platform
In our journey towards bringing DeFi to the people, we haven’t been alone. Among many others, RSK’s blockchain has played a significant role in developing DeFi platforms such as Money On Chain and RIF On Chain. Money On Chain developed the first-ever bitcoin collateralized stablecoin, allowing Bitcoin holders to earn a passive income by staking their BTC. RIF On Chain (ROC) offers a fast and secure platform for transacting RIF-backed products as well as an opportunity for RIF token holders to generate a passive income. You can experiment with the RIF tokens with our RWallet and Defiant.
Want to know more about DeFi? We invite you to visit our recent DeFi Round of Experts. Stay tuned!