Interest in Decentralized Finance (DeFi) has skyrocketed over the years, as its promise of greater security and transparency proves itself a welcome alternative to the highly regulated, tightly controlled environment of traditional financial institutions.
Since early 2020, the DeFi ecosystem has exploded in growth, with its market cap reaching over $26 billion by the end of that year. Growth continued throughout 2021, reaching a high of $199 billion. Today, despite dropping over the past few months, the total value locked in DeFi is $51.7 billion. Even with fluctuation, its total value has increased by over 4x since July 2020.
To understand what’s driving its growth and the promise that it holds, below is a greater look at the DeFi landscape.
What is DeFi?
When it comes to understanding DeFi, it’s best to start by taking a look at our current financial system. Dominated by large institutions, our traditional finance system relies on third party intermediaries such as brokerage firms, banks, credit card companies, etc. to operate as middlemen and facilitate transactions between users. It operates in a highly centralized, regulated and tightly controlled environment, often burying consumers with hidden fees and preventing others from participating altogether.
Simply put, DeFi seeks to decentralize the traditional financial services industry by removing intermediaries and automating complex financial processes. It replaces the roles of third parties, such as brokerage firms, banks, credit card companies and other centralized financial institutions, with smart contracts – simple, self-executing programs built on the blockchain that automatically carry out those functions. Ultimately, DeFi enables users to engage in independent peer-to-peer financial transactions, including borrowing, lending, trading, etc.
The core building block of DeFi is what’s known as decentralized applications (DApps).
As this white paper so thoroughly explains: “[DApps] make DeFi services fundamentally different to traditional financial services: being built on public, permissionless blockchain networks, DApps operate in a trustless environment. This means that responsibility for the security of operations and assets need not fall to a central intermediary, but is instead provided by the underlying blockchain network. Furthermore, with assets stored and transactions settled on a public blockchain infrastructure, users are able to hold the cryptographic keys to their assets directly without using a custodian.”
DApps are currently available for users in financial services such as trading, lending, investing, deposit, and payment solutions. For instance, TokenSets is a DApp-based platform for portfolio management. It allows users to set boundary conditions and investment objectives that TokenSets uses to trade, balance and implement strategies to achieve users’ goals automatically.
The Benefits of DeFi
Given that the primary aim of DeFi is to facilitate existing financial services in a decentralized way, its appeal is widely universal and offers various benefits for users. Some of these benefits include:
Accessibility/inclusivity: DeFi does not discriminate and allows anyone with a crypto wallet and internet connection to access services. Users can also make trades and move their assets whenever and wherever they want, without having to wait for bank transfers or pay bank fees
Real-time transactions: Users are able to complete transactions in real-time, as the underlying blockchain is updated the moment a transaction is completed.
Transparency: Every transaction on the blockchain is broadcast to and verified by other users on the network, making all transactions transparent and ensuring any user can check and audit network activity.
Programmability: Smart contracts are highly programmable and can be designed to automatically execute a particular rule without the need for human intervention or a third-party intermediary
The Future of DeFi
Ultimately, DeFi promises to make financial services more efficient through automation and cutting out the middleman. While some industry analysts are doubtful of the long term viability of a fully decentralized financial system, others believe that DeFi has great potential and will continue to grow in size and complexity. In an era where people have grown increasingly distrustful of traditional third-party financial institutions, it’s hard to imagine a future without DeFi.