As DeFi’s TVL Tops $100B, Here’s How DeFi Changes Everything
Decentralized Finance (DeFi) is a term that has been thrown around a lot throughout 2020 and the beginnings of 2021. What does it mean though, and why should you care?
In this article we’re going to look briefly at what DeFi is, why it’s important, and the ways in which it can change the world for the better.
What is DeFi?
Decentralized finance is an umbrella term for a wide range of fintech applications and platforms that are based around blockchain and cryptocurrency technology.
To understand the decentralized part, it helps to contrast it with traditional, centralized finance. Since financial services first became a thing, many years ago, they were always centralized systems.
In order to execute a transaction between two individuals or organizations – a central, trusted intermediary was always required. The middlemen, in the form of banks and other financial institutions, acted as gatekeepers to financial services and grew immensely powerful and wealthy while performing the crucial role of facilitating financial activity.
This is still true today with centralized entities controlling inflation rates, geographic barriers preventing millions of people from basic financial services, banks deciding who they will loan to, and very low interest rates for savers. Now though, technology has evolved to the point where the middleman isn’t necessary any more.
The Rise of DeFi
Enter DeFi. Bitcoin came along first, laying the foundation with the world-changing innovation which facilitated secure and trustless transactions between individuals without needing a trusted middleman.
Bitcoin was limited in a sense though. You could send, receive and hold the asset—in ways which brought significant advantages compared to traditional systems—but not much else. It took a further innovation to make DeFi a reality and expand the use of blockchain from a store of value and value transfers to more complex financial activity. Initially, this came a few years later in the form of Ethereum.
Ethereum was key for the emergence of DeFi because of the platform’s ability to facilitate smart contracts. Smart contracts automatically execute specific transactions if certain predefined conditions are met.
Ethereum is also programmable. Developers can build decentralized apps (Dapps) on the blockchain. These utilize smart contracts for specific use cases, using one of Ethereum’s native programming languages like Solidity.
Combined, this opened up the possibility of more complex financial activities to be moved to a blockchain-based, decentralized paradigm. DeFi exploded in 2020, seeing the total value locked (TVL) grow from $690 million to $12.7 billion between January and November alone.
Less than 6 months later though, that $12.7 billion looks puny, with TVL reaching an incredible $101.03 billion at the time of writing.
Now in 2021 we have decentralized exchanges (DEXs like Uniswap), lending platforms (AAVE), stablecoins (DAI), prediction markets (FTX), synthetic asset platforms that bring the stock market to the blockchain, and a host of other Dapps. DeFi users can borrow and lend assets, earn interest, bet, trade derivatives, take part in lotteries—just to name a few possibilities. Any traditional financial instrument can, and probably will, see a DeFi-equivalent emerge.
How DeFi Can Change the World’s Financial System
We’re only seeing the beginning of a whole new financial world. The benefits of DeFi continue to be demonstrated, as new protocols appear. Here are a few of those benefits.
1) No Trading Restrictions Like We Saw with GME
One of the great things about DeFi, and crypto in general, is that your money really is your money. There is no centralized authority watching over it, nobody can freeze your account and make you jump through hoops on whim, or confiscate your funds.
You have the keys, you control the funds, everything is under your supervision. There is no need for anybody else’s approval. DeFi is resistant to censorship in the sense that no powerful group, government, or corporation can declare you as “undesirable” and freeze all your DeFi assets. This is only possible with a trustless, decentralized system – DeFi.
The risks of relying on trusted middlemen were exposed for all to see during the Gamestop saga. Centralized stock brokers placed trading restrictions on several key securities at a crucial time—severely impacting some investors.
In a DeFi version of this same story, that could not have occurred. No one group of people could have the power to shut everything down. Indeed, synthetic stocks have already been made possible thanks to DeFi.
2) DeFi Cuts Down on Human Error and Increases Security
Many financial crises have had their roots in human error or corruption. While DeFi is not completely immune to this, the decentralized nature of the platform, the public ledger, and the cold logic of smart contracts can go some way towards mitigating this in the future.
Manipulating records stored on blockchain networks is nigh-impossible, and the cryptographic principles that underlie the system ensures that information is recorded only after its authenticity has been confirmed. This alone is great for consumers.
There are some real problems and concerns at the moment with some shady Dapps, but as the technology develops it can certainly become a more open and transparent financial system.
3) DeFi is Human Oriented Technology Aimed at Helping People
DeFi is also borderless and offers all users the same options regardless of their physical location or nationality. Carrying out financial transactions on a DeFi protocol is much the same whether you’re in Canada or Cambodia.
According to the World Bank, 21% of all adults across the world are “unbanked”, lacking access to a financial institution for basic services. This is mostly in developing nations, but is also surprisingly common in the US too. DeFi, if it meets its potential, can help the global unbanked and give them access to the financial services they need to thrive.
Another great advantage of the borderless nature of DeFi is that it allows for simple, fast, secure transactions across borders—a process traditionally full of headaches, waiting, and extortionate transaction fees.
4) DeFi’s Ultimate Potential is Unknown
The financial sector has been in sore need of “disruption” for a long time now. DeFi is the biggest shift happening in finance right now, and whenever you use it you are taking part in a massive global experiment that can change all our lives.
Due to the open-source, programmable nature of Ethereum—the system has been opened up for innovative minds and ambitious individuals to build upon, something that did not happen in the legacy financial world.
The concept of “money legos” refers to the (still largely untapped) potential of stacking and integrating different Dapps to create completely new decentralized products and services. There are thousands of potential applications that we have not even heard of yet—DeFi is bringing a completely new lens of innovation to the (previously) stale world of finance.
DeFi May Have Some Obstacles, but the Future is Bright
The nascent DeFi ecosystem still has some major problems to solve. Although solutions are starting to emerge, funds are not insured like they are in the traditional financial world—which will continue to hinder adoption until the issue is solved.
Transaction fees on the Ethereum network have also been absurd lately, but again this can be solved if the Ethereum team keeps their promises and gives the network the upgrades it needs.
Ultimately, the cat is out of the bag though. The possibilities of DeFi are so groundbreaking, and the potential applications so wide, that there is no going back. Whether it is on Ethereum or another blockchain, the future of finance is decentralized—and facilitated by smart contracts. We are in the early days, perhaps analogous to the internet in the late 90s. There’s a whole lot more to see and look forward to.
What do you think are the key advantages that DeFi will bring to the world? Do you see DeFi as a crucial aspect of the future of finance? Let us know in the comments below!