As the authoritative force in Employment and Labor Law today, we have, here at Miletti Law®,committed to creating enlightening and educative content, which aims to keep you, our unusually motivated® readers, #InTheKnow about issues that affect you and/or your businesses. Usually, the content features as videos posted on our YouTube Channel https://www.youtube.com/channel/UCtvUryqkkMAJLwrLu2BBt6w and blogs that are published on our website WWW.MILETTILAW.COM.

However, we also have a habit of sharing interesting yet insightful and enlightening content to break the monotony and keep you informed. Earlier this month, we introduced a very interesting concept involving the technology behind cryptocurrency known as Non-Fungible Tokens (NFTs) and the passive income they could create. You can find the videos on our YouTube channel and blog on our website, as indicated earlier. While we’re particularly interested in the associated intellectual property legal issues, we are also business-minded people at the end of the day.

That being said, we have introduced a brand new series regarding another phenomenon that has attracted a lot of attention and gained popularity lately called Decentralized Finance, or what is commonly known as DeFi. This concept is first introduced by the #MostUnusuallyMotivated attorney in New York and the lead partner/founder of Miletti Law® in a video titled “De=Fi Squared – Decentralized Finance, Simplified,” which is accessible in the link provided at the end of this blog.

Without further ado, hop in for a short and exciting trip in which we explore DeFi in depth.

What is DeFi?

As mentioned, DeFi stands for Decentralized Finance. In layman’s terms, a DeFi can be viewed as a financial system where financial products are made available to the public in a decentralized fashion. The principle idea behind DeFi is that it takes finances from the outside of pre-existing institutions that have been in existence since their inception and brings it into the open marketplace. Technically speaking, a DeFi doesn’t centralize financial functions, and money like traditional systems have always done.

To understand the concept better, let’s use an example of a bank and illustrate how DeFi is different in terms of being a decentralized system. For starters, most banks are perfect examples of centralized financial systems. The current system follows and operates under what is termed as a “hub and spoke” model. For instance, the U.S. Federal Reserve acts as the hub and all its branches as the spokes. Indeed, the desire to have a centrally controlled monetary system in the U.S. led to the creation of the Federal Reserve in 1913. For further elaboration, the financial industry also runs the same way. Usually, centralized locations such as London and New York act as hubs, and the rest of the financial industry spreads out as spokes. One of the critical functions of the hub and spoke framework concerns government-issued IDs (identity numbers) and Social Security Numbers being required to have bank accounts within the centralized financial industry.

Why DeFi and the Theory Behind it?

You might be wondering what the theory behind DeFi is. As a preliminary matter, we’ve mentioned that currently, we have the hub and spoke financial system or economy. We have centralized and isolated points of financial and economic powers, which spread outwards to reach other locations (spokes). It turns out that the problem with this kind of system is that when the hub suffers some sort of financial catastrophe, then the spokes suffer as well. Perfect examples include the 2007-2008 financial crisis and mortgage meltdown. Back to our question, the theory behind DeFi is that, as the name suggests, it separates, disengages, or disconnects the hubs from the spokes and vice versa, such that every single spoke stands independently and autonomous as a decentralized financial institution or system of its own.

From a laissez-faire free-market perspective (we are big fans of laissez-faire here at Miletti Law®), that’s the ultimate goal because decentralization forms a market of its own volition. Such a market has its own financial and capital assets, bears all risks and opportunities, and makes all decisions on its own without the need to rely on a hub. When you are a laissez-faire oriented person, freedom in the marketplace implies that you have the right to buy, the right to try, the right to win, and the right to lose. While you can’t have one option without the other, you have the right to enjoy all, even losing.

How Does the DeFi System Work?

It turns out that the systems function through a series of software and smart contracts and obviously the blockchain marketplace. In our series on NFTs, we mentioned that a blockchain acts as a kind of a digital ledger. It is through this ledger that all transactions take place, and, thus, its integrity has to be kept in check! It must also be secure, immune, and tamper-proof to any modifications. While the system software facilitates buying and selling back and forth along the blockchain, the smart contracts provide the necessary framework for the source code through which all relationships and transactions in the DeFi system are governed. However, the interesting aspect is that you agree to the terms in advance. However, it’s crucial to understand that DeFi is still a growing concept and in its infancy. Thus, a lot is expected to change over time with the advancement of technology.

What are the Layers of a DeFi System?

Popularly known as a four-layer DeFi stack, the system has four layers, as discussed below.

The Settlement Layer

In our series on NFTs, we talked about the blockchain marketplace, unique ledger, native currency (Ether), and native blockchain (Ethereum). It turns out that all these are contained within the settlement layer.

The Protocol Layer

This layer contains the smart contracts, system software protocols, rules & regulations, and the entire framework that supports the stability, functionality, and liquidity of the DeFi system.

The Application Layer

All consumer-facing applications are contained in this layer. A perfect example is a blockchain wallet.

The Aggregation Layer

Finally, an aggregation layer is the framework that facilitates the involvement of the service industry. For instance, it enables people to give out loans, trade-in cryptocurrencies, and liquidate the cryptocurrency into real money.

Where Can You Find the DeFi Platforms?

You’re already probably familiar with platforms such as Uniswap, Chainlink, and Luna Terra. However, although most people are unaware, the most common and popular blockchain platform is Ethereum, where Ether is traded. Ether was initially designed to be the primary token on the Ethereum blockchain. One interesting aspect of Ether is that it has undergone consistent growth with a market cap of $500 billion as of May 2021.

What are the Pros and Cons of a DeFi System?

Pros

  • Permissionless – Yes, you don’t require permission from a centralized financial institution to trade.
  • Accessibility to third parties – This system unlocks unlimited opportunities and opens up revenue currency and streams even for people from the remotest part of the world.
  • Immunity – the system is simply more secure than paper money because they use tamper-proof techniques like cryptography and consensus algorithms.

Cons

  • Uncertainty – most people don’t like taking the risk of uncertainty. Instead, they prefer safety to uncertainty, particularly due to the volatility issues involved with such kind of an investment.
  • Liquidity – if you’re barred from cashing out your money, then you’d have a huge liquidity problem in your hand.
  • Missing Protections – one characteristic of the blockchain market is anonymity. This means that if you make a wrong transaction or transfer your money to the wrong person, you won’t get it back.

As mentioned, we, here at Miletti Law®, are pro-laissez-fairefree market and, thus, we believe that people should have more autonomy and freedom when it comes to what they’d like to do with their finances without worrying about the federal government.

We invite you to review the video at https://www.youtube.com/watch?v=LxZXaoTQOZ8

Stay tuned for the next installment, and always be #UnusuallyMotivated. In the interim, if there are any questions or comments, please let us know at the Contact Us page!