What is DeFi?
Decentralised Finance (DeFi) is an approach to reinventing the financial system whereby individuals and private entities can access trusted financial and contractual services without the involvement of middlemen or intermediaries such as banks. It is based on the concept of distributed ledgers used by cryptocurrencies.
Simply put, the institutional intermediation between the banks and customers is being replaced with decentralised platforms that ensure seamless transactions between two parties through the use of smart contracts.
Why Do We Need DeFi?
Loans, mortgages, and high-interest savings accounts are made available in DeFi with turn-key technology. There are no traditional banks, no government-issued money, no private entity monopoly, no hassles, no bureaucratic headache.
To understand the purpose of DeFi further, we need to examine the system of money we are familiar with — Centralised Finance (CeFi) and why it needs to change.
CeFi Vs DeFi
- Centralised Finance (CeFi): is the traditional financial system wherein money and the authority over how that money is spent is held by banks, corporations and other third parties who are driven by profit and heavily policed by the government. In this system, there are several third parties involved who facilitate the exchange of money and their services are capital intensive, thus costing a high fee to access. There is also a high level of bureaucracy involved in the processing that makes many financial instruments inaccessible due to the high entry barrier, especially in third world countries.
- Decentralized Finance (DeFi) services provide unrestricted access to funds that can be exchanged, loaned, or invested at the touch of a button, anywhere in the world with an internet connection through the use of distributed financial databases and personal wallets. These distributed databases are accessible across various databases and verify the information aggregated from all its users through a consensus mechanism.
What can we do with DeFi?
The underlying infrastructure for DeFi is still in its nascent stages and so there is a regulatory gap in its use. However, as the cryptocurrency market has grown, so too has DeFi and the range of its capabilities.
Here are some of the types of transactions you can carry out with DeFi
- Lend: With DeFi, you can lend out your cryptocurrency and earn interest. The terms of loan in DeFi is highly flexible and interest payable are relatively lower than what banks offer.
- Get a loan: Obtain instant loans without paperwork. DeFi has also innovated flash loans which are extremely flexible too. They can be short-term loans not often offered by traditional centralised financial institutions
- Trade: Buy and sell crypto assets through P2P channels without the need for a brokerage. Crypto trading is highly profitable and is one of the most common ways to earn in crypto
- Save: You can use DeFi services to put some of your crypto assets into crypto savings accounts at high-interest rates. Many stable currencies are preferred as a savings option to edge against inflation.
- Buy derivatives: DeFi provides access to the crypto version of futures contracts or stock options. You can make long or short bets on certain assets.
- Build Financial Solutions: You can build an app on several DeFi platforms, many of which are fully suited with custom-made tools for developers to build easily.
Popular DeFi platforms
Despite having only been around for a relatively short period of time, some DeFi platforms have risen to prominence. Various DeFi systems, most of which were based on Ethereum, had about $20 billion worth of assets locked up as of November 2020. The following year, the DeFi market was valued at $250.55 billion, representing a 1,000 per cent increase in a single year.
Here are a few popular DeFi platforms:
🚀MakerDAO
MakerDAO is one of the oldest and largest DeFi projects, with a total value of $19.3 billion locked in, accounting for roughly 18 per cent of all dollars invested in DeFi projects at the moment.
🚀Aave
Aave is a decentralized financial platform that allows users to lend and borrow cryptocurrencies. People want to lend crypto in order to earn interest or borrow money in order to pay interest.
🚀Fantom
Fantom is a smart contract platform for dApps and digital assets that is open-source. This platform makes borrowing, lending, and trading synthetic assets much easier. All you have to do now is log into your digital wallet and deposit tokens to begin earning.
🚀PancakeSwap
PancakeSwap is unique in that it is built on the Binance Smart Chain rather than the Ethereum blockchain. As a result, trades are both cheaper and faster. It has grown at a breakneck pace as the popularity of BSC has grown.
🚀Compound
Compound is a type of liquidity that allows you to borrow and lend money. When you deposit money into Compound, you’ll get CTokens, which you can use to buy other cryptocurrencies on the platform.
Future of DeFi
The evolution of decentralized finance is still in its early stages. The ecosystem, however, still has architectural flaws and vulnerabilities. For starters, it is unregulated, which means that infrastructure failures, hacks, and scams continue to plague the ecosystem. According to a study conducted by the London-based firm Elliptic, more than $10 billion in user payments were stolen in incidents of fraud and theft on DeFi systems in 2021.
Reports like these have gotten the attention of government regulators, with some calling for tighter restrictions. In August 2021, the US Securities and Exchange Commission recommended that DeFi be regulated more strictly, implying that some DeFi platforms may be breaking securities laws.
However, the exponential growth of DeFi in recent years has been aided by a number of macro and technological trends. Whether through decentralized exchanges, lending and borrowing of various asset types, or insurance products, DeFi is rapidly evolving and expanding to mirror the traditional financial services ecosystem. DeFi will hugely impact global finance in the coming years and can displace centralised finance as a relevant alternative if it can improve in the areas of scalability, security, and simplified interface.
Would you like to know how to invest and benefit from the rapidly growing DeFi ecosystem, our next article on DeFi Series II will address the many benefits to be had. Don’t miss it!
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