The Rise of DEFI
The digital revolution for an opaque financial world
We currently find ourselves at the dawn of a new era: DECENTRALIZATION.
The decentralisation of finance, in particular, has become a hot talking point, driven by the public’s growing disillusionment with the centralised financial sector and its shortcomings.
More than ever before, individuals are calling for control of their personal data, ownership, and money, and decentralisation is being marked as a possible solution.
DeFi is an open and global financial system built for the internet age — an alternative to a system that’s opaque, tightly controlled, and held together by decades-old infrastructure and processes.
It gives the user control and visibility over his money. It favors exposure to global markets and alternatives to anyone’s local currency or banking options.
DeFi products open up financial services to anyone with an internet connection, and they’re largely owned and maintained by their users, and so far, tens of billions of dollars worth of crypto have flowed through DeFi applications, and it’s growing every day.
DE-centralized FI-nance
The use of technology in financial services is not new.
However, the role of technology is restricted to being a facilitator of such transactions. Companies still have to contend with navigating the legalese of jurisdictions, competing financial markets, and different standards to make a transaction possible.
DeFi is a collective term for financial products and services that are accessible to anyone with an internet connection since it is commonly placed in the domain of blockchain and cryptocurrencies.
Services that were previously slow and at risk of human error are automatic and safer now that they’re handled by code that anyone can inspect and scrutinize
Lowering the entry requirements of the finance industry, catering to the underbanked, and expanding the reach of services and commerce opportunities, to name only a few examples. Needless to say, the decentralised finance (DeFi) options being developed right now are already empowering and helping individuals in inflation-crippled countries and is likely to have a significant impact on the financial industry of the future.
With the expansion of the Internet by the end of 2025, the total amount of internet users reached an estimated 4.41 billion — this type of connectivity and accessibility is the game-changer for fintech and DeFi solutions. Combining all these factors with the convenience of these systems, decentralisation is democratising finance.
DeFi vs Traditional Finance at a glance
One of the best ways to see the potential of DeFi is to understand the problems that exist today in our Centralized Financial system (or CeFi):
- Some people aren’t granted access to set up a bank account or use financial services;
- Lack of access to financial services can prevent people from being employable;
- Financial services can block you from getting paid;
- A hidden charge of financial services is your personal data;
- Governments and centralized institutions can close down markets at will;
- Trading hours are often limited to business hours of specific time zone;
- Money transfers can take days due to internal human processes;
- There’s a premium to financial services because intermediary institutions need their cut.
In stark contrast to that DeFi offers:
- The user holds his money and has complete control over the assets;
- DeFi is open to anyone with an internet connection;
- Transfer of assets happen in minutes with little or virtual microscopic fees;
- The privacy of the user is protected via pseudonyms;
- The markets are always open;
- It’s built on transparency — anyone can look at a product’s data and inspect how the system works.
The nitty-gritty purpose of the ecosystem is to establish an open-source, peer-to-peer, transparent, and permissionless ecosystem without any central authority owning the power over financial transactions.
The Building Blocks of DeFi
DeFi is an open-source movement. The DeFi protocols and applications are all open for the user to inspect, fork, and innovate on.
Because of this layered stack (they all share the same base blockchain and assets), protocols can be mixed and matched to unlock unique combo opportunities.
The whole system is based on a stack of 4 components:
1) Settlement Layer
The settlement layer is also referred to as ‘Layer 0’ because it is the base layer upon which other DeFi transactions are built.
It consists of a public blockchain and its native digital currency or cryptocurrency. Transactions occurring on DeFi apps are settled using this currency, which may or may not be traded in public markets.
One example of the settlement layer is Ethereum and its native token ether (ETH), which is traded at crypto exchanges.
(More about Ethereum on my previous article ‘Beyond the skies of Ether’: )
The settlement layer can also have tokenized versions of assets, such as the U.S. dollar or tokens that are digital representations of real-world assets. For example, a real estate token might represent ownership of a parcel of land.
2) Protocol Layer
Software protocols are standards and rules written to govern specific tasks or activities. In parallel with real-world institutions, this would be a set of principles and rules that all participants in a given industry have agreed to follow as a prerequisite to operating in the industry.
DeFi protocols are interoperable, meaning they can be used by multiple entities at the same time to build a service or an app. The protocol layer provides liquidity to the DeFi ecosystem.
One example of a DeFi protocol is Synthetix, a derivatives trading protocol on Ethereum. It is used to create synthetic versions of real-world assets.
3) Application Layer
As the name indicates, the application layer is where consumer-facing applications reside. These applications abstract underlying protocols into simple consumer-focused services.
Most common applications in the cryptocurrency ecosystem, such as decentralized cryptocurrency exchanges (DEX) and lending services, reside on this layer.
4) Aggregation Layer
The aggregation layer consists of aggregators who connect various applications from the previous layer to provide a service to investors.
A DeFi aggregator brings together trades across various decentralized finance platforms into one location, saving users time and increasing efficiency for cryptocurrency trades
For example, they might enable the seamless transfer of money between different financial instruments to maximize returns. In a physical setup, such trading actions would entail considerable paperwork and coordination. But a technology-based framework should smoothen the investing rails, allowing traders to switch between different services quickly.
Lending and borrowing is an example of a service that exists on the aggregation layer. Banking services and crypto wallets are other examples.
How does DeFi work?
At a broad level, the components of DeFi are the same as those for existing financial ecosystems, meaning they require stable currencies and a wide variety of use cases.
DeFi components take the form of stablecoins and services like crypto exchanges and lending services, while smart contracts provide the framework for the functioning of DeFi apps because they encode the terms and activities necessary for the functioning of these services.
For example, a smart contract code has a specific code that establishes the exact terms and conditions of a loan between individuals. If certain terms or conditions are not met, collateral could be liquidated. All of this is conducted through specific code rather than manually by a bank or other institution.
The smart contract replaces the financial institution in the transaction with the feature that NO ONE can alter that smart contract when it’s live — it will always run as programmed.
Learn about smart contracts and their functioning in the following article:
Smart contracts are also public for anyone to inspect and audit. This means bad contracts will often come under community scrutiny pretty quickly.
The open-source based community helps keep developers in check, but this need will diminish over time as smart contracts become easier to read and other ways to prove the trustworthiness of code are developed.
Scaling to Success
Money and finance have been around in one form or the other since the dawn of human civilization.
Financial markets can drive the prosperity of society by enabling great ideas to become reality, but power in finance is still centralized: most people are locked out of decisions about what gets funded and get only a small portion of the profits from those projects.
Decentralisation offers a new promise, but has yet to reach the realm of necessary operating capacity to totally replace existing infrastructure and DeFi is not unfamiliar with that: the ecosystem is still riddled with infrastructural mishaps and hacks where scams also abound in the rapidly evolving infrastructure.
DeFi “rug pulls,” in which hackers drain a protocol of funds and investors are unable to trade, are common, though there are well-established protocols that can reduce this risk significantly.
Although facing substantial challenges, developers and companies worldwide are working to make the ecosystem a safer place: a better user experience, ease in usage and interaction, security, and institution regulations will fuel the technology to new highs, empowering the individual with full control over assets and access.
DeFi is democratization of finance
Is it likely that decentralisation will completely replace centralisation in finance? Yes and no.
Centralised finance has until now come across as the most trustworthy option, but is also affected by a multitude of issues causing increasing public disenchantment. What is more likely is that a hybrid of both systems will be the future of finance, offering the best of both worlds to end-users.
