What is DeFi? And how will it shape financial services?
Cryptocurrency’s goal is to make money and payments universally accessible to everyone, no matter where they are in the world.
The Decentralised Finance (DeFi) or Open Finance movement takes that promise a step further. Imagine a global, open alternative to every financial service you use today — savings, loans, trading, insurance etc— accessible to anyone in the world who owns a smartphone and has internet connection.
This is now possible through smart contract blockchains, like Ethereum. “Smart contracts” are programs running on the blockchain that can execute automatically when certain conditions are met. These smart contracts enable developers to build far more sophisticated functionality than simply sending and receiving cryptocurrency. These programs are what we now call decentralised apps, or “dapps”.
You can think of a dapp as an app that is built on decentralised technology, rather than being built and controlled by a single, centralised entity or company.
While some of these concepts might sound futuristic–automated loans negotiated directly between two strangers in different parts of the world, without a bank in the middle– many of these dapps are already live today. There are DeFidapps that allow you to create stable-coins (cryptocurrency whose value is pegged to the U.S. dollar), lend out money and earn interest on your crypto, take out a loan, exchange one asset for another, go long or short assets, and implement automated, advanced investment strategies.
Below are the basics behind Defi:
Data within financial markets are controlled by a small group of stakeholders that control pricing, access and what kind of data is being provided. In the U.S. alone, the industry is estimated at $15 billion, but only a handful of players control it. Decentralised finance will help democratise data, how data is sourced, how it is presented and create a rewards system that incentivise market participants.
DeFi lending is based on the benefits brought by the Ethereum blockchain, which allows for transparent and secure protocols to source and secure funds that are incentivised with various crypto rewards. DeFi has seen innovation such as no-collateral loans, compounding interest rates that are much higher than traditional banks, and P2P lending that helps eliminate intermediaries that operate their businesses around fees.
DeFi lending is currently seeing massive growth as companies leverage the industry’s composability, which allows applications to integrate and build on top of one another creating a vast network effect. This open-source approach helps promote innovation and encourages healthy competition, something that the cutthroat financial services industry desperately needs.
3. Decentralised Exchanges
Decentralised exchanges (DEX) are one of the most important innovations in the blockchain industry, as users are always in control of their funds, which are stored in external wallets. This alleviates the risk that comes with depositing crypto into exchanges, which can lead to losing all of your funds in the case of a hack.
In the past 30 days, decentralised exchanges have processed over $740 million in transactions, and are currently taking market share from more traditional centralised exchanges. As more traditional assets become digital assets, it is safe to assume that these will eventually be traceable on exchanges that are decentralised. Naturally, regulatory hurdles could make this a delayed process, but industry experts are confident in the power of DeFi with how we control our assets.
4. Asset Management
When thinking about asset management, Defi offers distinct advantages. According to DeFiRate, these benefits include non-custodial ownership of assets, composability to seamlessly plug in DeFi products with other products, automation, global access and financial inclusion and pseudo-anonymity.
The one potential downside is that users are completely responsible for their funds, and there are no safeguards to protect funds that are lost in wallets or sent to the wrong address. This is not for everyone, but the good news is that DeFi products are evolving at a rapid pace to become more user-friendly and educational, to help teach people how to properly manage their assets within the industry.
As mentioned in the last point, there are no automatic safeguards or custodians to protect users against user errors. Thankfully, there are DeFi insurance products that can help mitigate risk. This insurance can be applied to pools, personal wallets and smart contracts that are used to pool money for lending and staking.
Currently, there are nearly 10 DeFi insurance providers that are all helping to create an ecosystem that is based on transparency and accessibility. Their goal is to eliminate costly traditional insurance agencies that run as monopolies over certain sectors and make insurance more affordable and flexible to both institutional and casual users.
Future of DeFi
The industry is on a rampage, with more than $4 billion in assets locked up in DeFi projects. Currently, the DeFi industry is growing by nearly half a billion dollars per week, as investors and entrepreneurs find refuge in a financial system that is not tied to any government or corporation.
Arguably even more interesting is the movement of institutional investors and traditional finance professions to DeFi, as a way to break free from what is often considered to be an outdated and insular financial system. The current DeFimovement is being powered by Ethereum, which offers an open unregulated system that is easily available to everyone. This interoperability helps companies scale products by easily leveraging other innovations in the industry.
As the industry matures, more resources will be allocated to build DeFi solutions. Currently, there are a handful of exciting developments and projects, either recently launched or launching soon, that have the DeFi community excited, and for good reason — community involvement is at the core of DeFi, and one of the leading advantages over the traditional financial services markets.
Entrepreneurs should keep DeFi on their radar as the industry matures and continues to attract significant capital investment.
What do you think about Defi and its future role in finance? Leave your comments and thoughts down below.