In our attempt to shed light on people new to DeFi, we will start by first going through the basics of how traditional financial institutions work. For simplicity, we will focus on the highest leveraged institutions in the traditional financial system, the banks, and discuss its key areas to see the potential risks.

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The Banks

Banks are the financial industry’s giants that facilitate payments, accept deposits, and offer lines of credit to individuals, businesses, other financial institutions, and even governments. They are so large that the total market capitalization of the top 10 banks in the world is $2 trillion. In April 2021, the total market capitalization of the entire cryptocurrency market surpassed $2 trillion.

Banks are vital parts of the moving machine that is the financial industry—they enable money to move around the world by providing value transfer services (deposit, withdrawal, transfers), extending credit lines (loans), and more. However, banks are managed by humans and governed by policies that are prone to human-related risks such as mismanagement and corruption.

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Decentralized Finance vs. Traditional Finance

Friction, inaccessibility, and regulatory uncertainties are some of the major issues plaguing the current banking system. Unfortunately, not everyone is privileged to be banked in the current financial system, nor can they compete financially on a level playing field.

One only needs to look at the conundrum behind the GameStop (GME) trades, where a bunch of small-time investors decided to buy GME shares because big-time hedge funds heavily shorted it. Financial apps like Robinhood had to step in and restrict GME trades because of “extraordinary volatility”. Some might take this at face value, while others will note that one of Robinhood’s biggest customers is Citadel LLC. Citadel is a company that invested in Melvin Capital, which lost billions of dollars over their short on GME.

The DeFi movement is about bridging these gaps and making finance accessible to everyone without any form of censorship. In short, DeFi opens up huge windows of opportunities and allows users to access various financial instruments without any restriction on race, religion, age, nationality, or geography.
When comparing both traditional and decentralized financial products, there will be pros and cons on each side. In this book, we will walk you through the concepts and possibilities of decentralized finance so that you will know how to use its best features to solve real-world problems.