DeFi Roots: What is DeFi in the Crypto World?

This guide explains the four pillars of DeFi: artificial intelligence, big data, cloud computing, and distributed ledger technology.

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DeFi explained

Decentralized Finance (DeFi) is not a legal or technical term. Nonetheless, it is being used more frequently in discussions about the future of finance and its regulation. Decentralization, distributed ledger technology (DLT) and blockchain, smart contracts, disintermediation, and open banking are all common applications of DeFi.

While DLT and blockchain are used to support token-based ecosystems in decentralized systems such as Bitcoin (BTC), they are not the only means of achieving decentralization. Furthermore, many distributed ledgers use a hierarchical, centralized governance model that limits access to those with authority. In contrast, decentralized does not always imply scattered.

Disintermediation, like disintermediation, is not a prerequisite for decentralization; rather, it may be a (side) effect, given that the costs of centralized infrastructure will be difficult to recover in a world where services can be delivered in a distributed or decentralized manner.

This article will go over the four pillars of DeFi, which are artificial intelligence (AI), big data, cloud, and distributed ledger technology (DLT).

DeFi intelligence

Moore's law, Kryder's law, and another pattern that has yet to be labeled are important technological growth patterns for the DeFi space. Moore's law states that data processing capacity increases at an exponential rate. According to Kryder's law, the same holds true for data storage capacity.

The combination of ever-increasing processing power and data storage capacity results in ever-increasing cost savings for both. The rapid expansion of communications capacity combined with lower prices is the third reason that enables DeFi. Increased network efficiency, which results in more bandwidth per dollar invested, lends support to the underlying assumption of increased bandwidth at lower costs.

These three evolutionary patterns enable hardware virtualization: software is hosted, updated, and run on decentralized servers rather than on each workstation. Only data that must be handled locally (in the case of an instant online connection and plenty of bandwidth) will most likely be processed locally.

Hardware virtualization enables the development and deployment of service-oriented architecture (also known as "software as a service"), which is central to DeFi. Interestingly, Moore's law, Kryder's law, and bandwidth expansion at falling costs all apply concurrently, implying that machine learning (ML) and other types of artificial intelligence (AI) will advance.

ABCD: The roots of DeFi

At the heart of DeFi are four technologies best represented by the abbreviation "ABCD," which stands for Artificial Intelligence, Big Data, Cloud, and Distributed Ledger Technology (including blockchain and smart contracts). Although these concepts will be familiar to many, we'll provide a quick overview of the underlying technologies to help you understand the policy implications of DeFi.

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Artificial intelligence

AI is based on the concept of developing software that mimics human cognitive abilities such as "learning" and "problem-solving." The more data there is, the more insightful and accurate the inferences drawn from it. Similarly, the more data there is, the more insightful and precise the inferences drawn from it.

Machine learning is a subset of AI that uses statistical, data-driven methods to gradually improve the performance of computers on a specific activity without the need for humans to reprogram the system. In reality, learning occurs through extensive "practice" and repeated feedback rounds in which the machine is informed whether it has succeeded or failed at a task. Artificial intelligence for blockchains in this context refers to a digital ledger that intelligent digital agents can access.

One of DeFi's primary advantages is the vast amount of public data generated around financial transactions. This massive amount of financial data can be used to train and develop artificial intelligence models, such as arbitrage bots, which attempt to maximize profits based on expected asset price movements.

Current AI applications in DeFi technologies are only scratching the surface, particularly as the amount of data available expands and the types of DeFi services proliferate.

In DeFi, an example of AI is, a machine learning lab based in Cambridge, is developing a decentralized artificial intelligence platform based on a distributed ledger that enables secure global data sharing, connection, and transactions.

Security of intellectual property (IP) is critical to the success of any financial technology (fintech) company, including the rapidly growing DeFi industry. While there are many ways to protect AI developments, one popular method is to keep the underlying data used to train AI models a trade secret. For many businesses, the data used to train AI models is one of their most valuable pieces of intellectual property.

When the underlying data is publicly available and has almost certainly already been used to train competitors' AI models, businesses must rely on alternative methods to protect their intellectual property. Techniques for acquiring or pre-processing blockchain data prior to AI training, for example, could be protected as trade secrets or patents.

Big data

Data is at the heart of all DeFi innovation, which is the result of the digitalization of an increasing number of processes: the concept of "digitization of everything," which underpins fourth industrial revolution theories.

The growing volume of data supports both traditional data analytics and big data techniques. Big data analytics refers to the collection and analysis of data sets that are too large or complex for traditional data processing programs.

Big Data applications use modern data analytics methods to find unexpected correlations, test expected correlations for causality, or calculate the likelihood of a predetermined pattern. DeFi data analysis thus refers to the act of identifying, interpreting, and communicating relevant patterns in DeFi protocol data, as well as the process of applying such patterns to make better decisions.

Big Data Protocol is a commercial platform for exchanging data and services. It collects commercial data from professional data suppliers, tokenizes it, and liquidates it on Uniswap via the DeFi protocol and the Web 3.0 marketplace. Users can earn data by providing liquidity to data tokens.

Cloud computing

The decentralization of server capacity is referred to as decentralized cloud computing. Instead of using a single server at a single server center, datasets can be distributed across multiple server centers that are more or less concurrently accessible via the internet by a large number of users from all over the world.

Cloud computing is the delivery of on-demand data storage and processing capacity without the need for users to own or operate the servers that provide these services. Cloud computing is based on commercial data centers that rent capacity to customers who connect via the internet.

Cloud service providers typically connect server centers across time zones, countries, and economic regions to provide cloud stability in the face of volatile demand and energy supply, diversify against demand peaks, and ensure economic operations in environments where energy costs fluctuate throughout the day. They also direct excess demand to servers, where data processing capacity is less expensive due to lower demand and energy costs.

Unsurprisingly, the increased use of cloud-based computer infrastructure has prompted the development of workable solutions to existing problems. Among the solutions presented as alternatives to traditional cloud computing services, the use of a decentralized or peer-to-peer paradigm appears to be popular.

Such solutions are based on nodal blockchain-based networks of cloud service providers that autonomously share and secure cloud computing resources. In essence, cryptography aids in the security of networks in DeFi and cloud services.

Distributed ledger technology (including blockchain and smart contracts)

Continue reading to learn more about distributed ledger technology in blockchain.

A distributed ledger is a database that is shared and synchronized by consensus across networks that span multiple sites, institutions, or continents, allowing a transaction to have multiple private or public witnesses. Data sharing generates a database that is distributed across a network of servers and serves as a ledger.

Distributed ledgers are distinguished by the lack of, or minor presence of, centralized management and the absence of centralized data storage. They are thus "distributed," in the sense that the software-driven interactions of many participants result in the authorization to record a specific piece of information.

When combined with cryptographic solutions, such features (decentralization and distribution across a network of computers) reduce the risk of data manipulation, eliminating the need to rely on third parties, particularly data storage service providers, where the data is stored and most easily manipulated.

The best way to understand distributed ledgers is to compare them to their adversary, the concentrated ledger. Assume that all relevant data is stored in a centralized register that is managed by a single entity. Contrary to current practice, the centralized record is not secure and is thus semi-distributed via a slew of backups stored on multiple servers.

A centralized setup comes with a number of risks. For starters, if the hardware on which the register is "placed" is destroyed, the information content and authority to verify its accuracy are lost. Second, dishonest database administrator employees or unfaithful administrators may tamper with the information content of the register. Third, a cyber-attack can result in data loss and alteration.

Distributed ledgers, which raise the barrier to manipulation, address these issues. The underlying technology must be agreed upon by a large number of data storage points (nodes). For example, if there are n nodes (rather than a single focused ledger) and e describes the effort required to break into any single server, the effort required to manipulate all the linked servers will be n*e rather than 1*e if all other conditions are met.

In conjunction with distributed ledgers, a blockchain protocol is frequently used. What blockchain is all about is the storage of data in data bundles (called blocks) in a strict time-related series, with each block linked to the previous and following blocks via a timestamp, as well as several protocols providing evidence of a user's authorization to alter the data stored.

Because a successful cyberattack would have to corrupt not only one set of data but all subsequent data sets (i.e., the entire blockchain) as well as the timestamps, the blockchain makes data corruption even more difficult.

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Smart contracts, a new concept aimed at addressing the issue of trust in human interactions while also increasing efficiency, have found fertile ground on distributed ledgers. They are software protocols that run on their own and represent some of the terms of a two-party agreement. They are neither intelligent nor legal contracts.

The contract terms are directly encoded into lines of code. Smart contracts enable transactions to be carried out between dissimilar, anonymous parties without the need for an external enforcement mechanism (such as an arbitrator, a court or a central clearing facility).

Transactions are thus transparent, traceable, and irreversible. Smart contract-driven processes can take place and be recorded on blockchain-secured distributed ledgers. This particular combination is central to the majority of DeFi debates.

The interrelationships between ABCD and DeFi

Because they are used to achieve decentralization, these four rapidly emerging technologies are frequently critical to it. Many decentralized financial functions, for example, make use of I AI's powerful efficiencies and cost-savings; (ii) smart contracts embedded on distributed ledgers secured by blockchain's superior record-keeping and efficiencies; (iii) cloud systems to host nearly all decentralized financial processes; and (iv) the potentially decisive power of algorithmic data analysis.

Each of these four technologies is less expensive, more convenient, and efficient to use, allowing for decentralized collaboration among the numerous participants who provide financial services.

Building an entirely new financial system: The DeFi ecosystem and its architecture

The true value of DeFi is derived from the clever integration of modularized financial primitives such as stablecoin, borrowing/lending, and exchange. The blockchain (also known as layer zero) provides the level of trust and security in DeFi. Layer one is above layer zero, and it is here that the DeFi ecosystem's critical financial operations, such as a decentralized stablecoin for payments, are developed.

The next level (layer two) provides users with access to far more advanced features such as lending/borrowing and asset trading. Layer three and more advanced financial services built into decentralized applications (DApps) will come after that (e.g., decentralized exchanges or DEXs).

Finally, on aggregation layer four, user-friendly DApps combine many features to create a service similar to what we now have in banking apps: storing and transmitting money, investing in assets, borrowing against these assets (leverage trading), and so on.

In the past, DeFi projects have proven to be profitable ventures. Many of these projects' development teams keep a large portion of the token supply or electronic shares used to regulate and protect the mainnet's operation.

This not only allows the team to profit from price speculation, but it also allows the company to be a party to the protocol's proper operation, giving it advantages in effectively securing the network's proper functioning.

How is DeFi's vision different from Wall Street?

DeFi aspires to build a completely decentralized, censorship-free, low-fee, fully automated, and counterparty-free alternative banking system from the ground up. DeFi, like Ethereum (ETH) and Bitcoin (BTC), is permissionless in the sense that anyone can contribute code and use these open-source protocols, regardless of social status or country of origin.

In the traditional banking system, these two variables frequently define and, in some cases, limit one's ability to be served. DeFi, for example, democratizes financial services, particularly those that are only available through large institutions, such as customized derivatives. Furthermore, in DeFi, these derivatives have much lower face values than in traditional financial markets.

So, given all of this rebuilding of pre-existing financial products, what is the difference between DeFi and the conventional financial system? In DeFi, every DApp is open source, and every transaction is transparent. This is also true for DApps with higher aggregation levels.

Wall Street, on the other hand, appears to be a black box, requiring the user to believe that the institutions do what they say they do. Rigid compliance standards, as well as strict regulation and oversight by state authorities such as the Securities Exchange Commission and Financial Conduct Authority, ensure financial stability, consumer safety, and fraud prevention.

The effectiveness of centralized systems (financial services firms) cannot be denied. In comparison to open source and decentralized DeFi applications, customers have far less visibility into how their bank spends their money. To summarize, if Bitcoin is a modern, digital, and decentralized alternative for exchanging and storing value, DeFi is a complete modern, digital, and decentralized alternative financial system.

In the not-too-distant future, algorithms and decentralized computer programs will govern how value is created, exchanged, transmitted, and converted into financial instruments and derivatives. The financial industry, which has traditionally performed this function, will change as this technology, dubbed DeFi, replaces historical financial infrastructure and ushers in an era of "integrated value exchange."

This method creates a completely new paradigm for the exchange of value. Within the next decade, you may be able to walk into your favorite store and pay with a digital wallet comprised of various assets you own. Perhaps some fiat currency (e.g., USD), Bitcoin, digital collectibles (e.g., nonfungible tokens, or NFTs), and possibly even some short-term debt to fund the remaining purchase price (i.e., a DeFi loan). As a result, it's possible that you'll soon be able to pay for everyday items with tokenized representations of your home's equity.

Furthermore, at the checkout counter, you would simply scan your smartphone over the cashier's point-of-sale system, which would initiate a transaction from your universal wallet (containing all of your assets). Your assets would be immediately swapped and sent to the merchant in whatever currency they chose to accept, based on the assets you chose to pay with.

While there may be some additional challenges in realizing this vision across all asset categories, such as determining the value and obtaining liquidity for unique assets like real estate, these are not insurmountable. In the future, cross-asset value transfer will be seamless.

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