Decentralized Finance (DeFi) In a Nutshell
Decentralized Finance, better known as ‘DeFi,’ has the potential to revolutionize the banking and finance industry. In this article, we are going to take a closer look at what Decentralized Finance is, why the world needs DeFi, and who DeFi products help the most, and why.
DeFi products distribute financial services and make them more accessible, easier to obtain, transparent, and trustless. Recently, there has been a large focus on DeFi in the blockchain and cryptocurrency space. More and more teams have been building products that provide users with these decentralized financial services that make banking and finance a permissionless, self-sovereign activity.
What is DeFi?
Decentralized Finance can be described as financial services that do not require an intermediary or trusted third-party to be facilitated. At the moment, there are DeFi platforms that allow you to lend, borrow, margin-trade, and trade without permission from an intermediary or third-party. The fact that these financial services can be provided without permission is an unprecedented event in the world of banking and finance. Typically, if you need banking or financial services, they must be facilitated or approved by a financial intermediary or third party. But thanks to DeFi, as long as you have access to the internet, you have access to financial services. Considering that there are 1.7 billion unbanked people — people without access to financial services — decentralized financial services have the potential to provide tremendous value to the world.
Why The Market Needs DeFi
For several people, banking and financial services are hard to obtain. This happens when there are no banks or financial institutions in their area, or there are, but they are difficult to access. However, DeFi platforms give individuals the ability to take full control of their banking and finance needs. Due to DeFi, you no longer have to apply for financial services and wait for a bank or third-party to approve you for those services. Or worry about the integrity of the system or service you wish to participate in. And if you are part of the unbanked population, you don’t have to worry about your ability to access financial services.
On DeFi platforms, you can interact with smart-contracts — code that can facilitate, verify, or enforce the negotiation or performance of a contract — whenever you wish to have access to banking and financial services. The smart-contracts that you interact with execute on-chain in most cases. This means that all of the aspects of banking and finance that traditionally happen in a black-box, are transparent and can be viewed on a block-explorer.
Users of DeFi platforms can look directly into the platforms and services they are using. This means users can see if there is a sufficient amount of collateral backing these platforms and if the platforms really have the reserves that they are telling users that they have. Because they can do this, communities can avoid situations that have happened in traditional finance like the Enron scandal, where dishonest accounting practices were used to hide the actual value of the company and its reserves.
In addition, to access and use DeFi platforms, all you need is an internet connection, a device that connects to the internet, and a cryptocurrency wallet. This gives billions of people around the world access to financial services like lending, borrowing, trading, and margin-trading. Services that they would not readily have access to without DeFi, especially if they are part of the unbanked population.
According to the World Bank president Jim Yong Kim, “having access to financial services is a critical step towards reducing both poverty and inequality, and new data on mobile phone ownership and internet access show unprecedented opportunities to use technology to achieve universal financial inclusion.”
This goes to show the impact that decentralized financial services have on the world — especially when it comes to improving the quality of life for the billions of unbanked and underserved peoples, and nations.
Now, if you live in a country with a stable economy, non-volatile currency, and easy access to financial services, then Decentralized Finance might not pique your interest. However, to the 1.7 billion unbanked people in the world and the individuals who live in economically unstable countries, these offerings are game-changing.
Who DeFi Products Help the Most and Why
Decentralized financial products provide the most value to the unbanked, financially underserved populations, countries with volatile currencies, as well as businesses and individuals who find it difficult to obtain banking or financial services through the traditional system.
Not every country has an easily accessible brick and mortar bank or financial institution. Therefore individuals who live in these countries may not have the means to set up a bank account or apply for financial services like a loan. As a result, unbanked households are practically forced to keep all their wealth in cash since they do not have a checking or savings account. However, in a Decentralized Financial ecosystem, as long as individuals have internet access, they will have access to the services offered by banks and financial institutions.
Some Decentralized Financial platforms like MakerDao’s DAI allow individuals to mint stablecoins — cryptocurrencies pegged to non-volatile real-world assets. These offerings can be crucial for individuals that live in countries with extremely volatile currencies, allowing their citizens to store their wealth in a stable asset that is unlikely to fluctuate as much as their native currency. For example, as of March 2019, the Organization for Economic Cooperation and Development (OECD) estimated Argentina’s inflation rate for the year (2019) would be around 34%. However, if a citizen was to store their wealth in a stablecoin like DAI, they could rest assured that the DAI will stay roughly equivalent to the USD. This means that they wouldn’t have to worry about their currency rapidly losing purchasing power year after year.
Even individuals that do live in stable countries with strong economies can find Decentralized Finance offerings advantageous. For example, small businesses and start-ups without credit history typically have trouble obtaining a business loan from the bank. However, through Decentralized Finance platforms like MakerDAO, these individuals can take out a collateral-banked loan, and use the DAI that they mint to fund their business operations. And they can do all of this without having to apply for a loan or undergo a credit check.
Why Decentralized Finance is Revolutionary
Decentralized Financial offerings can revolutionize finance in the same way that media was transformed and disrupted by the internet. Before the internet, access to media and news was limited to what was shown to you on the television and what was printed in the newspaper. However, these were relatively exclusive activities with significant barriers to entry. But with the advent of the internet, the exclusivity and barriers to entry in the media space were removed. Afterward, a variety of well-informed individuals gained the ability to publish media that could be viewed by a global audience.
Similarly, DeFi gave anyone with internet access and a cryptocurrency wallet the ability to obtain all the services that they would typically get from a bank or financial institution — without working through a bank or financial institution. The impact that this innovation has had on the lives of many people should not be overlooked. As the president from the World Bank mentioned, financial inclusion plays a crucial role in reducing poverty and inequality. But beyond that, DeFi offerings have the potential to disrupt the traditional banking and finance system that is currently in place.
Banks and financial institutions make some of their income from being the middleman. However, DeFi platforms remove the middleman from the equation. When you remove an intermediary from an equation, processes usually become cheaper, and settlement tends to occur faster. This is because you are removing the third-party that typically takes a few days and charges a fee for facilitating the service you desire.
DeFi platforms quickly became popular in the blockchain and cryptocurrency space among the unbanked, financially underserved, financially limited, and blockchain and cryptocurrency enthusiasts. DeFi platforms gave these groups access to banking and financial services that were not under the control of an institution, organization, or government for the first time in many of their lives.
Traditional finance is effective, however, it is centralized and provides the greatest benefits to those that run the system, and those with the resources, knowledge, and access to the services offered by conventional banks and financial institutions.
But for the first time, DeFi platforms gave everyone — not just economically well-positioned people — access to banking and financial services. The financial inclusivity created by DeFi offerings plays a significant role in improving the quality of life of nearly anyone who finds it beneficial to use Decentralized Financial services. At the moment, DeFi platforms are the blockchain and cryptocurrency platforms with the most users, and if the cryptocurrency market continues to grow, you can expect the usage on these platforms to grow with it.
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