NFTs and DeFi: what are they and why should you care?

Dan Annan

Cosmos Asset Management

One of the concepts at the very heart of the blockchain world is “decentralisation.” It refers to the transfer of control and decision-making from a centralised entity (one individual, one organisation, or one authority) to a distributed network. To many people, this might sound chaotic, but the strength of the concept lies in its simplicity – through decentralisation, no single person or group has control. Rather, everyone in the network collectively retains control.

This has huge ramifications for virtually every industry, but in finance, “decentralised finance, or DeFi, brings with it particularly profound change,

DeFi is an emerging financial technology based on secure distributed ledgers similar to those used by cryptocurrencies. The system removes the control that banks and institutions have over money, financial products, and financial services. In essence, DeFi uses blockchain technology to remove third parties in financial transactions.

DeFi is “trustless” because it eliminates the need for participants to know or trust each other for the system to work; or for a central entity (such as a bank) to have authority or control over the system. Any transaction can be verified by the people or groups that are party to it. DeFi is also “permissionless,” because the system lets anyone participate, and does not require an application and approval from a central authority (again, like a bank) to use it.

At present, DeFi as a term refers to financial products and services that are accessible to anyone who can use Ethereum, which is by far the leading blockchain for DeFi and “smart” contracts (self-executing digital versions of traditional real-world contracts). Self-executing applications called dApps are used to conduct DeFi transactions: some of the services handled by dApps on Ethereum include peer-to-peer lending, derivatives, asset management, stablecoins, trading and insurance. DeFi aims to recreate financial systems like banks and exchanges.

And with the attributes of blockchain technology, it has a fair chance of achieving this. Already, people are lending, borrowing, earning and paying interest, and trading cryptocurrency like they can in the physical markets.

DeFi’s attractions for its users include:

  • It eliminates the fees that banks and other financial companies charge for using their services.
  • You hold your money in a secure digital “wallet” instead of keeping it in a bank.
  • It gives you alternatives to your local currency or banking options.
  • Anyone with an internet connection can use DeFi-hosted services without needing approval.
  • You can transfer funds in seconds.

DeFi is also at the heart of the emerging non-fungible token (NFT) trend, which rides on it. NFTs are unique cryptographic tokens that exist on a blockchain – a “token” means a unit on a blockchain – and cannot be replicated. That’s where the “non-fungible” comes in: because there can only ever be one of that item, it can’t be fungible – a term that describes a currency, commodity (a gold bar, or a barrel of oil), security, or any other item that is interchangeable with other units of the same kind.

A cryptocurrency is a fungible digital asset; one Bitcoin is always equal to another Bitcoin. It’s that fungibility that makes it tradeable, and a trusted means of conducting transactions on the blockchain. But NFTs have unique individual characteristics that mean they are not interchangeable. Nor are NFTs divisible: they always remain whole.

This one-of-a-kind quality makes NFTs perfect for individual intellectual property tracing, and indeed, that is how they have become most widely known – as a means for creators to create unique digital artefacts, and sell them to buyers for whom the NFTs represent ownership rights. Mostly NFTs have been used to sell digital works of art, pieces of music, in-game items and videos, as well as copyright ownership, licensing, and royalty sharing.

But there is no reason why the NFT ecosystem should remain limited to digital intellectual property – it can also be used for other digital assets, such as digital “land” in virtual reality. NFTs could also be used in the physical world, to enable the digital transfer of real-world goods and assets. Almost any real-world physical asset could be “tokenised,” for easier proof of ownership and exchange of ownership – simply using blockchain technology to record who owns the asset, and thus, enabling it to be traded. NFTs give every appearance of being natural assets for DeFi.

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DISCLAIMER While every care has been taken in the preparation of this article, Cosmos Asset Management Pty Ltd (ABN 34 639 356 068) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not an indication of future results. The information provided is general information without considering any investor’s objective, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information provided and seek professional advice, having regard to their investment objectives, financial situation and needs. The information provided in this article is general in nature and has been prepared without taking into account any investors objectives, financial situation or needs. Cryptocurrency may not be suitable for all investors, so please ensure that you fully understand the risks involved and seek independent advice prior to making any investment.

Dan Annan
Dan Annan
Chief Executive Officer
Cosmos Asset Management

Dan is the CEO of Cosmos Asset Management and is responsible for leading the business operations and strategic direction. He has extensive experience in the local and global funds management industry, with over 15 years dedicated to Exchange...

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