DeFi
Financial business without the party that normally sits in between
What is it?
The same business as in a bank - only without the bank.
Someone investing money does not place it with an institution but in a protocol. Someone borrowing does not apply for anything but deposits more than they receive. The rules are in the code and run without anyone’s involvement.
What falls away is not only the effort. Vetting, liability and the complaints desk fall away too. No institution to verify customers, no deposit protection, no supervisor to step in.
An example
At a bank you get interest because the bank lends the money on and carries the default risk. If a borrower goes under, that is the bank’s problem, not the saver’s.
In a lending protocol you get interest because others borrow there. If something goes wrong - a flaw in the contract, a wrong price, an over-indebted position - you carry your share of it yourself. There is no balance sheet in between.
Where does a risk come from?
Not from any single risk, but from the fact that all of them land on the user at once.
| No buffer | There is no equity to absorb losses first. Whatever goes wrong comes straight out of the deposits. |
|---|---|
| No vetting | Anyone can take part, the attacker included. There is nobody to turn them away beforehand. |
| No supervision | No rulebook requires reserves, audits or reporting. What a provider does, it does voluntarily. |
Why this matters for cover
Because cover here takes the role equity and supervision otherwise play - but only for the cases set out in the wording.
A cover replaces neither supervision nor deposit protection. It covers one particular, described event. Everything beside that - price losses, your own mistakes, a protocol that was simply bad - stays with the user.
Where this leads
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Seven ways it can go wrong.
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The building block most of this business rests on.