A brief on DeFi - Decentralized Finance and the Future

DeFi expands on Bitcoin's promise of digital money and replaces Wall Street completely digitally, with no associated costs (office towers, trading floors, bank employee salaries, etc.). This has the potential to create an efficient, fair, and open financial market that anyone with an internet connection can use. Currently, DeFi makes up only five percent of the crypto space but is growing at an exponential rate.

In 1990 finance computerization was increased due to internet access to the public due to which access to bank accounts, wire transfers, and buying stocks was possible from the comfort of your house. Later on, the Fintech revolution came that included companies like PayPal Robinhood transfers revolt and other fintech startups. All offered seamless access to financial services through the internet.

 

History and revolution of financing 

- 1920 accounting machines and punch cards

- 1950 mainframe computers

- 1970 ATMs and credit cards

- 1970 stock market radical transformation from manual entries and loud trading pits to trading from computers and algorithms

 

The problem with this financial system was that it wasn't perfect. It took days for the settlement of stock, bonds, and other financial instruments. It requires a massive amount of human capital. The effect that financial institutions have is on millions of people and those decisions are taken by very few privileged people behind closed doors. International transactions are highly expensive and take a lot of time. Other problems include such as billion-dollar banking scandals and massive inefficiencies due to human error. The financial system consists of siloed systems built with proprietary technologies and algorithms. And if we take about an entry in the market for creating a new financial institute the barriers of entry are very high. The backbone of banks has not evolved much since mainframe computers. 

 

DeFi is an abbreviation for decentralized finance and is a general term for peer-to-peer financial services on the public blockchain-centered on Ethereum. DeFi leverages the power of cryptography, decentralization, and blockchain to build a new financial system that accesses well-known financial services like payment, lending, borrowing, and trading in a more efficient, fair, and open way. DeFi is generally as global as crypto assets, peer-to-peer (direct interaction between two parties, not via a centralized system), anonymous, and open to everyone. 

 

The benefits of DeFi are its Efficient operations are immediate, counterparty location doesn't matter and the DeFi protocol can be operated with no human or minimum human involvement. 

 

You can move assets anytime, anywhere. Services are permissionless and censorship-resistant. To use this financial service, you just need the internet and no party can deny access. Furthermore, DeFi is OPEN. Application processes are not required for opening an account. You can use it just by creating a wallet. Everything is transparent and visible to blockchains such as trading volume, debts, etc and these numbers cannot be tempered. DeFi democratizes access to trading and audits and accounting is available for everyone. The interest rates are adjusted automatically by demand, supply, and risk parameters.  

 

How does it work?

Users typically use DeFi through software called dapps (“decentralized apps”). Most of them are currently running on the Ethereum blockchain. Unlike traditional banks, you do not need to fill out an application form or open an account. This is how DeFi is being used today. Lending crypto assets and earning interest and rewards every minute instead of once a month is one of the key advantages. One can get a very short-term "flash loan" or another loan that traditional financial institutions don't offer immediately without having to fill out paperwork. There is the Peer-to-peer trading of specific crypto assets. Now you can buy and sell stocks without going through any intermediaries. By depositing some of your crypto assets in an alternative to your savings account, you will generally get higher interest rates than you would receive from a bank. The option to take a long or short position on a particular asset is optional. These are the cryptocurrency versions of stock options or futures contracts. 

 

Introduction of Ethereum 

Ethereum smart contract platform allows for creating any arbitrary financial application. Due to these characteristics, Ethereum became the go-to blockchain for DeFi activities. Defi has seen huge growth in the last few years. The key metrics are an increase in total value locked in various DeFi protocols, growth from less than one billion (April 2020) to 32 billion (Feb 2021). Another important metric is trading volume growth from half a billion dollars in April 2020 to 50 billion dollars in Jan 2021, almost a 100X increase. The total value settled on Ethereum is one trillion dollars as of 2020.  

 

What are the disadvantages?

Fluctuations in transaction rates on the Ethereum blockchain can make active transactions expensive. Depending on the app you use and how you use it, your investment can be highly volatile – this is a new technology. You are responsible for maintaining your tax filing records, and regulations may vary by region.

 

Is DeFi the future of finance?

DeFi is cheaper, and faster. Many companies across the world are jumping on to the blockchain and DeFi trends as a means to future-proof themselves. The technology for DeFi is also evolving at a rapid pace to disrupt, equal, or even surpass the centralized financial services in the future. To sum it up, DeFi will have its era in finance. 


 

By: Husnain Babar

 

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