In July 2020, the Total Value Locked (TVL) in DeFi grew from $2.03 bn to $2.23 bn in 3 days. That’s a fifth of a billion US Dollars in less than half a week! This goes to show the pace at which the DeFi space has been growing recently and what we can expect from it in the future.
DeFi, or Decentralised Finance, is the talk in the crypto town nowadays and this is the place where you can find out what it’s all about. To begin with, let’s take a brief look at how DeFi came to be.
Traditional finance which is the only version of finance we’ve ever known (at least in our lifetimes) has been largely centred around intermediary institutions such as banks and governments. Why is that bad you ask? Well, the issue with that is, we have to put our trust in these institutions to make the right calls on behalf of us, regarding our money.
We trust our government to maintain the economy and the value of our currency. We trust our banks for the safe storage of our money. Even when it comes to investing, we again have to place our trust in various financial advisory companies to handle our money responsibly. But despite placing all our wealth in the hands of these centralised institutions, in the end, we get little to no say in how these institutions function and handle our wealth.
So, with this level of centralisation and opaqueness deeply entrenched in the current financial system, there is a need for something that would take control of our wealth back from these institutions and place it in our own hands. And THAT’S where Decentralised Finance comes into the picture.
Benefits & Offerings of DeFi
DeFi offers a great advantage over traditional finance as it aims to create an open-source, transparent, permissionless, trust-less financial ecosystem that can operate without any central authority, and is available to everyone who has a smartphone with an internet connection.
This is done by taking components of traditional financial ecosystems and decentralising them. Essentially eliminating the middleman and in doing so increasing the benefits for both the producers and the consumers. This is possible now because of blockchain.
The users in this ecosystem have full control over their assets and can interact with the DeFi ecosystem through P2P decentralised applications called dapps from anywhere in the world. These dapps are built on top of a blockchain and all of their protocols are completely open-source. The blockchain in question here is the Ethereum blockchain. And the Ethereum blockchain is a programmable blockchain. Meaning, developers can make use of it to make something known as ‘Smart Contracts’.
Smart Contracts are programs that run on the Ethereum blockchain and are executed automatically when certain conditions are met. In other words, you can think of them as a digital escrow. Since smart contracts are digital, their terms are written and enforced in computer code. This property makes smart contracts easier and faster to use with a reduced risk for all the parties involved. Smart contracts enable developers to build far more sophisticated functionality rather than simply receiving and sending cryptocurrency. These programs are actually what we termed as decentralized apps or dapps earlier.
To give you a little taste of what Decentralised Finance is capable of, here’s an example. Imagine – taking out a loan, not from a bank, but from a random stranger sitting in their house on the other side of the globe, instantly. Yes, with DeFi, this is possible, not in the future, but right now!
DeFi Ecosystem & Products
So, there are a lot of neat things you can do in the DeFi space. One thing to note here is that while these applications might sound futuristic, most of them are live today! This means that you can go online right now and use any of these dapps to meet your financial needs. Mentioned below are some of the examples in a few popular categories.
- Maker – a decentralised credit platform on Ethereum that supports Dai, a stablecoin You can also create your own Dai stablecoin using Maker Oasis dapp. Also, people who hold a separate (but related) token MKR, can vote on many important decisions like debt ceilings, stability fees, and many other important things.
- Compound – an open-source money market protocol on Ethereum, that lets its users borrow or lend assets against some collateral. In simpler words, using it, you can lend your cryptocurrency out and earn interest on it. Or you can deposit your cryptocurrency as collateral to the Compound smart contract, and borrow against it.
- Uniswap is a decentralised cryptocurrency exchange running entirely on smart contracts, that lets you trade popular tokens directly from your crypto-wallet. In addition to trading, Uniswap lets any user become a liquidity provider, by giving their cryptocurrency to the Uniswap contract and earn a share of the exchange fees.
- Augur is a decentralized peer-to-peer and oracle protocol for prediction markets on Ethereum. Augur lets you create a market around the outcome of any real-world event.
- Synthetix is a decentralized platform on Ethereum that lets its users create and exchange Synths (synthetic versions of real-world assets like gold, silver, and traditional currencies like the USD). These synthetic assets are backed by excess collateral locked in the Synthetix contracts.
- Flexa is a payment network that enables merchants to accept digital currencies without the risk of fraud, volatility through off-chain collateralization.
- Request Network is an open network for transaction requests. It allows anyone to create, store, and access invoices, receipts in a universal and decentralized network.
- Loadscan is a software that monitors and analyses financial transactions in real-time on the Ethereum blockchain. It’s a dashboard showing the best interest rates to earn passive income or lowest interest rates to borrow crypto.
- Etherscan is a block explorer and multipurpose analytics platform for Ethereum.
- UniswapROI is a calculator that helps you analyse your investments in Uniswap and find the best liquidity pools.
Things To Look Out For
- Smart Contract Risk – Since DeFi products are based on self executing Smart Contracts, there is a security risk that users need to be aware of. Historically, a single bug in smart contracts has led to irrecoverable loss of funds or locking up of millions of dollars.
- Early Days – Most DeFi projects are still in the public beta phase. Users must understand that risk before investing a huge chunk of their money in these protocols and applications.
- High Volatility – Since project tokens are publicly traded and the distribution is still fairly concentrated, the speculation and macro sentiment swings token prices drastically. Users participating in the DeFi ecosystem open themselves to that risk.
One thing to note here is that this is just Day-1 for DeFi. As this space grows and evolves, the critiques of DeFi will have an increasingly harder time to pinpoint the negatives of this space.
The Way Forward For DeFi
An Open Financial system, aka DeFi, has created new ways in which anyone, regardless of their geographical location can grow wealth with interest-bearing accounts, lend or borrow stablecoins, and cryptocurrencies. This Open Financial system operates on blockchains, which are open-source, transparent, and auditable by anyone. The infrastructure for this modern digital economy is almost in place. The number of DeFi projects is increasing every week and more investors are becoming interested in DeFi. But still, this is all just the beginning for DeFi.
We are seeing tremendous innovation in the DeFi space and with innovation, comes solutions. DeFi might have to catch up with traditional Finance at first. But once it does, it’s nothing but the open road for DeFi and you can bet your bottom dollar that you’ll be seeing a lot better and fair financial services in the future – all thanks to DeFi.