DeFi or decentralized finance is on the verge of disrupting the world of traditional finance. Financial services provide the lifeblood for most other industries. Yet, they are centralized and dependent on the decisions of the people that control them. DeFi isn’t controlled by a central source which gives users direct control over their money. One of the main advantages of DeFi is that it eliminates the middleman.
The term DeFi was first introduced in 2018, but 2020 was the year that DeFi came into its own. In January 2020, the Total Locked Volume TLV of assets in DeFi was $681 million. By the end of the year, the TLV had reached $16 billion, boding well for the future of DeFi.
Decentralized finance can’t tolerate price volatility. Yet the cryptocurrencies on which they depend are very volatile. So, the industry has tokenized real assets, creating stable coins. Stable coins track the value of actual assets stabilizing prices.
How DeFi Works
DeFi includes applications and financial tools. These build on the blockchain concepts introduced by Bitcoin. They allow for peer-to peer lending, trading, insurance and investment. They cover almost any service offered by the traditional banking sector. All this is based on smart contracts. Anyone with an Internet connection can access the contracts. They are enforceable and need no intermediaries.
Most DeFi applications reside on Ethereum, the second-largest cryptocurrency platform after Bitcoin. The reason Ethereum is used is that it offers users flexible, smart contracts. The Ethereum programming languages have been designed for the creation and deployment of these types of contracts. This flexibility makes it easy for users to write any conditions they please into the smart contract.
DeFi lending platforms connect cryptocurrency borrowers with lenders. It’s DeFi’s most popular use. Because the platforms request collateral, usually in ether, borrowers don’t have to identify themselves nor undergo credit checks. There is no waiting for approval and algorithms calculate the interest based on supply and demand.
Offering access to the unbanked
DeFi gives users easy access to an enormous number of financial services. Users can take loans without application approval or even a bank account. Because there are no administrative requirements 1.7 billion unbanked people across the globe have access to these products for the first time. There are no intermediaries so the products should be cheaper than those offered by traditional financial services providers.
Because DeFi apps, or dapps, are resident on block chains they are very secure. Once the chain picks up a transaction, no-one can change it. Block chains are decentralized, so no individual has control over the performance of the assets. This prevents the kind of interference that took place in the traditional banking sector during the Covid-19 pandemic. As a result, people with invested money faced reduced interest rates imposed by the Central Bank.
Block chain transactions can be tracked back to their owners meaning that they are more secure than fiat currencies. You can do anything with a crypto currency that you can do with a fiat currency using a dapp. Transactions happen immediately and interest rates are continually updated.
The Future Looks Bright
Millions of people now place their trust in the DeFi system. This is possibly one of the fastest growing technological products on the market today. DeFi boasts $61 billion in market cap and it is one of the fastest growing sectors in the blockchain environment.
As the volume of transactions has increased so have the costs per transaction. This is likely to lead to cross-chain technology allowing crypto-currencies from one blockchain to transact on another.
Decentralized finance is growing and will likely quickly catch up with traditional financial systems. DeFi is set to do to the world of finance what cloud technology did in replacing servers. DeFi is set to reshape the financial industry as we know it.