DeFi Simplified: Why Decentralized Finance is transforming FinTech
DeFi, or Decentralized Finance, is the rising umbrella term for the new set of financial tools, platforms and services built on decentralized technologies. DeFi is largely made possible by the enhancements in smart contracts, blockchain infrastructure and the growing adoption of crypto.
Ethereum is by far the most popular protocol supporting the myriads of DeFi apps running on its decentralized network. In total, the entire total value locked (TVL) in DeFi reached $12.38 billion in October according to DeFi Pulse. The DeFi craze in September generated more than $16 million just in transaction fees alone on Ethereum.
Okay, enough of the numbers. So why is DeFi booming? To understand the exponential rally behind DeFi’s growth, we must first consider the current state of FinTech and how DeFi is challenging the current financial system that you’ve lived with your entire life.
Here are 3 key factors you need to know:
New tech, new possibilities
Before the birth of blockchain and crypto, which underpins the key infrastructure of DeFi, FinTech services were mostly (and still) offered by big names such as Paypal, Alipay, and your local bank down the street. These companies are highly centralized and use technologies built on the outdated financial infrastructure.
Slow payments, high fees and unsatisfying customer experience are just a few of the ongoing problems that many of us have experienced with these financial platforms. Although traditional FinTech has offered us more financial tools than ever before, there’s still an inherent limit to how much and how efficient these platforms can solve the fundamental pain points.
You can keep upgrading an old 1980s car, but no matter how much improvements you make to that car, it won’t surpass your neighbor’s fancy new dual-motor electric car. The fundamentals are outright different.
That’s how DeFi is to traditional FinTech. DeFi completely builds upon brand new technologies leveraging blockchain, decentralized networks, smart contracts and crypto. It completely redefines how people can choose to transact value, or money as we know it, with new services, faster transactions and lower fees. Of course, all of that without a central middleman. You are your own bank.
The possibilities of DeFi currently are still in discovery mode, with new lending and borrowing platforms on the rise. Other platforms such as staking, yield farming, insurance and tokenized assets are made possible — paving way to an enormous potential for people to invest and earn like never before.
As with all new technologies, do your own research and stay safe.
DeFi has no borders
In one aspect, DeFi’s focus revolves around the core idea of true accessibility. Stemming from crypto’s “be your own bank” approach, DeFi services can be accessed by anyone. Really, you just need the internet and the appetite to learn.
With traditional FinTech, you usually need to go through layers of registration and identification to set up accounts. To borrow money, whether it be for funding your next business or you simply want to lease a new home, you have to provide credit checks and lots of paperwork. DeFi eliminates them.
For nations with developing financial infrastructure, citizens still have deep challenges in accessing basic banking services. Over 1.7 billion people are still unbanked across the globe according to the Global Findex 2017 report. Opening a simple savings account is still a challenge, or citizens simply prefer not to hold cash due to the devaluation of their nation’s fiat currency.
How does DeFi address these issues?
DeFi has no borders. It’s universally open to anyone in the world. It’s a set of smart contracts that live by self-executing code that are “trustless”, meaning there’s no need for an intermediary to process the transaction.
Wherever and whoever you are, DeFi makes financial inclusion a stark reality for millions through efficient smart contracts. Accessibility is one key growth driver for adoption, and that’s what DeFi does well compared to legacy financial services. Welcome to internet money.
Lending and Borrowing Redefined
The national US average for a bank savings account is 0.6% APY — a mere fraction of what DeFi can offer with rates up to 20% commonly found on crypto lending and borrowing platforms.
The low APYs offered by established financial banks and lending platforms paints a stark contrast to the yield-earning platforms offered by DeFi. These platforms range from crypto lending and borrowing, “staking” of crypto collateral and yield farming techniques. Each of these have different risk levels and rewards, so do some homework before jumping on the bandwagon.
One prime example is yEarn, whose governance token’s price grew 3,500% in less than a month. These governance tokens typically represent the ability for platform users to vote on the project’s development, thereby the user community governs certain aspects of the platform itself. yEarn is a platform that aggregates different DeFi lending protocols such as Aave, dydx and Compound to earn the highest yields in crypto. Think of it as a robo-advisor that uses the latest DeFi technologies to earn you the highest yields possible with crypto.
These platforms earn interest and pay lenders in crypto through smart contracts. This makes frequent borrowing and lending much more efficient, and to some extent cost-effective compared to traditional lending companies.
Other platforms like Curve allow you to deposit funds in stablecoins, and earn interest without the risk of asset price fluctuations.
These lending and borrowing platforms all come together in different layers to form complex yield-earning systems. Lending platforms form the first layer (take Curve as an example), which are then accompanied by lending aggregator platforms (such as yEarn) on top to earn additional yield.
You can then stack additional layers that generate more yield. The combination can be simple or complex — the strategy and risk varies among users and DeFi projects.
DeFi in a nutshell
DeFi has grown exponentially due to its potential in disrupting existing financial services — including lending, banking and interest-earning platforms. DeFi builds upon the innovations of blockchain and crypto, enabling cheaper and faster financial services.
And don’t forget, it provides greater accessibility for everyone including those without bank accounts. Just imagine the explosive adoption of DeFi if millions of new users flood into the ecosystem, because the current global financial infrastructure simply cannot sustain the growing demands. DeFi can and has the tech to make it possible. It’s only a matter of time before DeFi becomes the new normal, at least for the FinTech world.
As with all new technologies, DeFi is still in the very early stages and will experience volatility. Speed bumps are expected as part of a growing ecosystem.
Always do you own research and be vigilant. Crypto never sleeps and moves at an astonishing rate — so can you.
