Is DeFi the Future of Finance?
The bright future of DeFi, a stunning technology that has transformed the crypto industry from grass to grace, is here.
How often have you looked at the newest business or financial news in the last 12 months to discover the media focused on bitcoin's price fluctuations? Cyber currencies have dominated the conversation concerning the future of Finance. But something else is happening, mostly unnoticed, that is deeper and is beginning to influence the entire financial system. It is the rise of DeFi or Decentralized Finance.
"With more institutional investors entering the DeFi industry, the market is predicted to rise to $800 billion in 2022".
Things change quickly in the cryptocurrency sector, and Decentralized Finance is a current trend - it's an exciting place to be. If you're still unfamiliar with DeFi, let's dive deeper and discover more about it.
What is Defi-Decentralized Finance?
Decentralized Finance (DeFi) is a financial system that operates on a network of computers rather than a single server. DeFi is a new digital financial infrastructure that eliminates the need for a central bank or government agency to authorize financial transactions.
DeFi is inextricably linked with blockchain, the Decentralized, immutable public ledger on which Bitcoin is based, which allows all computers (or nodes) on a network to keep a copy of the transaction history. The concept is that no single entity has control over or can alter the transaction ledger.
DeFi, in its most basic form, is about trading with an algorithm. I own Asset One and want to purchase Asset Two. Asset One is sent to the algorithm, and Asset Two is returned to me. It's straightforward – and effective. It's not impossible to picture a future in which we trade with algorithms or conduct business, in general, using algorithms - the benefit being that you eliminate the middleman, so there's no broker or bank. It is essentially a peer-to-peer transaction that is mediated by an algorithm.
Projects and Use Cases of DeFi
Here's a rundown of the most popular DeFi use cases and protocols in the market today:
DeFi Lending and Borrowing
DeFi revolutionized Finance by allowing lending and borrowing. Decentralized lending, often known as 'Open Finance,' provided crypto holders with lending options to earn annual yields. Individuals might borrow money at a fixed interest rate, thanks to Decentralized borrowing. Lending and borrowing are intended to satisfy financial sector use cases while meeting the cryptocurrency community's needs.
- Top DeFi Lending and Borrowing Platform: Compound Finance
Rober Leshner created Compound Finance, which debuted in 2018. The project is an Ethereum-based lending protocol that allows users to earn interest by lending assets or borrowing against collateral. The Compound protocol facilitates this by generating liquidity for cryptocurrencies via interest rates determined by computer algorithms.
Decentralized Exchanges (DEx)
Decentralized Exchanges (DEx) are an essential function of DeFi, with the most capital locked compared to other DeFi protocols. DExs enable users to exchange or swap tokens for other assets without needing a centralized intermediary or custodian.
Traditional exchanges (centralized exchanges) provide similar options, but the investments available are subject to the will and costs of that exchange. Another disadvantage of CExs that DExs address is the additional transaction cost.
- Top Decentralized Exchange: UniSwap
UniSwap, founded by Hayden Adams in 2018, is the largest automated token exchange by trading volume on the Ethereum blockchain. The project was launched after receiving funding from several venture capital firms, including the Ethereum Foundation. UniSwap uses smart contracts to automate cryptocurrency transactions.
Stablecoins are a viable solution to the volatility issues plaguing cryptocurrencies and assist DeFi in gaining prominence. For consistent prices, stablecoins are based on a relatively stable asset, such as gold or the US dollar.
Stablecoins became useful during risk-off periods in the crypto space, providing investors and traders with a haven. Because of their stability, they are dependable collateral assets. Stablecoins are also crucial in liquidity pools, which are essential to the DeFi ecosystem and DExs.
MakerDAO, founded in 2015 by Rune Christensen, is a company working on Ethereum blockchain technology for savings, borrowing, lending, and a stable cryptocurrency. This was one of the first projects to use DeFi protocols.
Instead of holding an ICO, the project privately sold $MKR tokens over time to fund development. Maker's stablecoin, $DAI, was launched in 2018 and has gained significant traction.
Prediction markets are platforms where individuals can make predictions about the outcome of future events ranging from sports betting or politics to stock price predictions. DeFi allows for participation in these markets. Decentralized prediction markets have long been touted as a possibility via smart contracts.
- Top Prediction Market: Augur
Augur is a Decentralized prediction market platform that uses the masses' collective prediction. August, a DeFi platform, uses Ethereum to tap into the "Wisdom of the Crowd" to generate real-time predictive data. Augur's first version was released in 2015, and its mainnet was launched in 2018.
DeFi also provides asset management as a service. It aims to make investing more efficient, less expensive, and accessible. Asset Management benefits from aspects of the DeFi ecosystem such as transparency, composability, and trustlessness.
Transparency promises to make information more accessible and secure, to allow for hyper-customization of portfolios, and to be trustless in accessing previously illiquid assets and managing their investment regardless of location.
Evan Kuo founded Ampleforth in 2020, intending to provide a non-collateralized digital asset to help traders and investors diversify their crypto portfolios. Ampleforth is a DeFi asset-management protocol designed to be synthetic and intelligent commodity money. "Synthetic" because they are created by humans but are not natural materials such as gold.
Benefits of DeFi
DeFi provides the following advantages.
- DeFi is open source and permissionless: DeFi services are accessible to anyone with a crypto wallet and an internet connection, regardless of location. Users can also trade and move their assets around without waiting for bank transfers or paying traditional bank fees.
- The transactions are carried out in real-time: When a transaction is completed, the underlying blockchain is updated, and interest rates are updated multiple times per minute.
- Transactions are transparent: Every transaction on the Ethereum blockchain, which accounts for over 90% of all DeFi traffic, is broadcast to other users on the network and verified by them. Any user can see network activity with this level of transaction data transparency.
- Users can keep control of their assets by using non-custodial cryptocurrency wallets or smart contract-based escrow.
- Smart contracts are highly programmable and can be programmed to execute automatically, based on an infinite number of variables.
- DeFi data is tamper-proof, secure, and auditable because of the use of blockchain architecture,
- Many DeFi protocols are available as open-source: Ethereum and other projects are built with open-source code that anyone can view, audit, and build on. Without permission, developers can easily connect multiple DeFi applications built on open-source technology to create new financial products and services.
- Decentralized apps are interoperable: In centralized Finance, for example, it may take days to transfer money from your broker to your bank or vice versa. DeFi does not have such a delay.
Risks and Challenges
DeFi provides new and exciting financial freedoms, but they are not without risk. These risks include:
DeFi Technology is Immature
DeFi technology is still in its infancy and has yet to be utterly stress-tested at scale over time. Funds may be lost or jeopardized.
For example, the DeFi platform Compound recently experienced a significant glitch in which users were erroneously handed millions of dollars in cryptocurrency. That’s why it’s vital to choose the right developers with a lot of experience in DeFi.
Lack of Consumer Protection
In the lack of rules and regulations, DeFi has blossomed. However, users frequently have little or no protection when things go wrong. There are no state-run compensation systems for DeFi, and no rules requiring capital reserves for DeFi service providers.
Threat of Hackers
Hackers are a danger. While hacking is a problem in traditional Finance, DeFi's broader technological architecture with several potential failure sources expands the attack surface available to sophisticated hackers.
For example, in August 2021, "white hat" hackers stole $610 million from the DeFi platform PolyNetwork by exploiting a smart contract vulnerability. Fortunately, all funds were restored.
Collateral Requirements are High
Almost all DeFi lending transactions need collateral equal to or greater than the loan's value. These conditions severely limit eligibility for many forms of DeFi loans.
Although DeFi has compelling use cases, we cannot fully trust the DeFi ecosystem because it is still in its early stages. It is still vulnerable to large hacks and thefts, and users should be wary of investing any money into DeFi protocols. However, at the current rate of advancement, the DeFi business is anticipated to improve soon.
DeFi-The Future of Finance
We've come full circle. Our first market exchanges were conducted through barter, which was inefficient. The introduction of money significantly improved efficiency. However, with DeFi, anything may be tokenized, including goods, services, art, and music, to name a few examples.
Thus, you will be able to choose how to pay in the future. Perhaps you pay for groceries with a gold-backed token; maybe you use one backed by IBM stock. It is all up to you. If your selection does not match what the retailer desires, a Decentralized exchange effortlessly converts your asset into what the store wants. This is barter, but it is effective barter. Central banks face competition in today's world. They lose their monopoly over money.
"There are numerous use case scenarios of DeFi that are beyond Finance. I'm hoping for a faster adoption since, in the end, they'll all be linked in a digital wallet, whether it's financial or not."
Co-Founder and CTO of Unstoppable Finance, Peter Grosskopf, said.
We, humans, have a natural desire to travel through time and a fascination with future predictions. Let's see how DeFi will be in the future.
Increase in DeFi Tokens
There are currently more than 100 DeFi Tokens in circulation. Popular cryptocurrency exchanges such as Binance, Okex, and Huobi have already listed DeFi tokens on their platforms. In the future, we can expect many new DeFi tokens, and many cryptocurrency exchanges will undoubtedly list them.
Crypto Lending Would Become Extremely Simple
Crypto Lending is DeFi's most popular application. In the future, DeFi will bring a secure ecosystem for super-simple asset-based crypto lending that will be faster and simpler than the current one.
DeFi Based Payment Gateways
Payment gateways based on DeFi provide lightning-fast transactions in seconds without charging a single penny as a cross-border transaction fee. Many popular e-commerce sites would include payment gateways like this on their websites.
DeFi in Banking
Many countries are preparing to launch Central Bank Digital Currencies to participate in the digital revolution, including the banking sector. It will come as no surprise if banks adopt Decentralized Finance.
Decentralized Finance is gearing up now, and if it provides user-friendly and high-security features, it will do wonders in the future.
The financial services industry is witnessing significant disruption due to technological advancements such as blockchain and distributed ledgers. What is certain is that DeFi is here to stay, Web3 is looming, and financial services will never be the same again.
Consumers should be able to use DeFi capabilities through the banking and insurance services provided by all financial institutions. Otherwise, they will be left in the dust by DeFi platforms and rivals who recognize the future, which combines ease of use and convenience with the power of Decentralized financing.