WHAT IS DEFI?
DeFi this, DeFi that - yes, we know, DeFi is everywhere. In fact, DeFi is what we do. So no matter whether you already know something about it or you are entirely new to the field, please allow us to show you around.
What exactly is DeFi?
DeFi is short for decentralized finance. Its advocates claim that this global, P2P system, which doesn’t entail either the structure or the restriction and costs of a traditional centralized banking system, can do everything a bank can. The one big difference is that DeFi does this faster and more transparently, thanks to smart contracts running on public blockchains.
Unlike a bank that relies on outdated and ineffective technologies, procedures, and infrastructure, DeFi capitalizes on the power of cryptography, decentralization, blockchain, and smart contracts, trying to lay the foundation of a new financial system.
Most DeFi projects are built on the Ethereum blockchain; the main reason behind this is that ETH’s programming languages, such as Solidity, are specifically designed for building and deploying smart contracts.
However, no matter what technology or platform is used, DeFi systems are created to eliminate the need for intermediaries between parties in a financial transaction.
What’s typical for DeFi?
Harnessing the power of blockchain, DeFi is permissionless, open-source, efficient, fair, resistant to censorship, cheaper than traditional banking, transparent, and tamper-proof.
Settlement of operations in DeFi happens almost immediately and doesn’t depend on geographic location, local laws, and regulations. What’s more, no or minimal human involvement is necessary.
Why is everyone talking about DeFi?
First of all, unlike most financial services (including opening an account with a cryptocurrency exchange), in DeFi protocols, there aren’t any legal requirements about KYC procedures.
Secondly, mainstream players are dipping their toes into the space. One such example is the endeavor of 75 of the world’s biggest banks, led by JP Morgan, ANZ, and Royal Bank of Canada, to speed up payments as part of the Interbank Information Network, which is why the banks are trialing blockchain technology.
Of course, we can’t ignore the elephant in the room, namely COVID-19. The recession caused by the pandemic has forced some central banks to cut interest rates, which unfortunately affects the effective net worth of savers. Thanks to DeFi, users can protect the value of their assets from unfavorable central bank decisions.
What problems in traditional finance does DeFi solve?
Now, to put DeFi’s value proposition into perspective, we need to outline a few problems in traditional finance and see how using DeFi can solve them.
We all remember the GameStop fiasco, during which investing app Robinhood and a few other stock brokers blocked trading of GameStop shares, among others. Such a scenario would have never played out on a decentralized exchange (e.g., Uniswap), as there is no single authority that can disable or limit the platform’s functionalities.
Traditional banking and trading are often associated with decisions made behind closed doors by a group of privileged few that impact millions if not billions of people around the globe. Contrary to that, DeFi allows for an automatic adjustment of interest rates, taking supply, demand, and risk parameters into account.
Another thorn in most people’s side is the notoriously steep bank transfer fees, not to mention the fact that sometimes it takes days for the transfer to reach its destination. In DeFi, not only will transactions arrive in the blink of an eye, but they also cost peanuts to send.
Nowadays, financial institutions keep hiring thousands of employees to maintain the inefficient processes that have been in place for decades. Thanks to blockchain and distributed ledger technology, far fewer human resources are necessary to keep the DeFi engine running.
What is more, because they follow predefined rules that apply to everyone, DeFi protocols don’t discriminate against people based on their location, ethnicity, age, or cultural identity. Unequal access to financial services affects billions of unbanked people globally, but DeFi has everything it takes to democratize the financial sector. That is possible as two-thirds of the unbanked have a smartphone, which means that they can avail themselves of all opportunities DeFi offers.
How exactly popular has DeFi been so far?
To answer this question, we will look at some of the key metrics in the space. Let’s start with Total Value Locked in DeFi – this represents the value of all tokens locked in various protocols. This number surged to more than $32B in February 2021 from under $1B in April 2020.
When it comes to the trading volume across decentralized exchanges, this metric registered a stunning 100x increase to over $50B in January 2021 from approximately $0.5B in April 2020.
Last year, the total value settled on the Ethereum blockchain reached over $1T, which is more than PayPal.
If we put volatile cryptocurrencies aside, we’ll see that within the DeFi ecosystem, stablecoins (pegged to fiat currencies, such as the US Dollar) also saw extraordinary growth.
The market capitalization of USDC, a stablecoin commonly used in DeFi, jumped from under $1B in April 2020 to more than $6B in 2021.
What challenges is DeFi facing?
To answer this question, we will look at some of the key metrics in the space. Let’s start with Total Value Locked in DeFi – this represents the value of all tokens locked in various protocols. This number surged to more than $32B in February 2021 from under $1B in April 2020.
When it comes to the trading volume across decentralized exchanges, this metric registered a stunning 100x increase to over $50B in January 2021 from approximately $0.5B in April 2020.
Last year, the total value settled on the Ethereum blockchain reached over $1T, which is more than PayPal.
If we put volatile cryptocurrencies aside, we’ll see that within the DeFi ecosystem, stablecoins (pegged to fiat currencies, such as the US Dollar) also saw extraordinary growth.
The market capitalization of USDC, a stablecoin commonly used in DeFi, jumped from under $1B in April 2020 to more than $6B in 2021.
Conclusion
Even though it is still a very nascent and high-risk industry, DeFi is our best shot at disrupting the traditional financial sector by providing users with more control over their money. If they want to avoid gradually becoming irrelevant, brick-and-mortar institutions will have to adapt quickly.
The train toward a new financial system left the station 11 years ago when Bitcoin came to be. Now with DeFi, a new car is being hitched to the train, one that brings us closer to revolutionizing the traditional financial industry and to a cashless society.
Over the next few years, the task that DeFi will have to deal with is minimizing the risks and spreading its benefits in the most liberalized way and as widely as possible.
We are in for the long haul; what about you?
