- DeFi or decentralized finance seeks to build an open-source financial system that minimizes friction and maximizes value for users
- DeFi solves some critical problems plaguing centralized finance, including limited access, centralized control, and inefficiency
- Growing from almost nothing, the DeFi sector is now worth over $100 billion
- If DeFi is to change finance by 2030, the sector will need to become regulated and offer more security
Decentralized Finance, or DeFi as it is commonly known, refers to a system where financial products are made available on a public decentralized blockchain network. Unlike traditional financial services, DeFi grants direct access to everyone, eliminating the need for intermediaries.
The history of DeFi can be traced back to Bitcoin, the pioneer crypto. Although many would not classify Bitcoin as a DeFi protocol, it created the groundwork for the DeFi sector. Bitcoin allows users to send payments worldwide in a decentralized fashion, a fundamental key of decentralized finance.
DeFi Vs. Traditional Finance
For centuries, the economies of the world have operated under traditional finance (TradFi). Central banks control the flow of money. Financial trading is largely done via intermediaries. Borrowing and lending are done through traditional banking institutions.
When DeFi first came on the scene, it was more of a curiosity and didn’t pose any serious competition to traditional finance. However, a few years down the line, now a $100+ billion sector, there are hints that DeFi is tomorrow’s finance.
The Problems DeFi Solves
- Limited Access: there are currently 1.7 billion unbanked people worldwide, making it difficult for them to operate in a growingly digitized economy. While TradFi limits access, DeFi allows anyone with internet to access banking services.
- Inefficiency: TradFi has many inefficiencies, including huge interest rates, intermediaries, and slow funds transfer. Decentralized finance protocols allow users to transfer funds quickly without going through any intermediaries
- Centralized Control: In centralized systems, banks control rates, fees, and in some cases, influence the inflation rate. However, decentralized finance allows the users to control the market and prices. This was evident in the GameStop saga.
- Lack of Interoperability: In TradFi, consumers deal with financial institutions in an environment that lacks interconnectivity. While cross-border transactions take weeks to be completed in TradFi, DeFi protocols can complete them in minutes.
- Opacity: Built on distributed ledger technology, DeFi allows anyone on a network to validate the authenticity of a transaction. Transactions are also immutable, meaning no changes can be made to a ledger after transactions have been logged in.
Decentralized Finance: The Face of the Future
The above problems paint a good picture of how many flaws exist in today’s traditional finance and how decentralized finance can improve finance in the future.
Decentralized finance challenges the existing system of centralized institutions with its peer-to-peer system that offers everyone access to banking services. There are no bricks and mortar, no chargebacks, and no loan interviews.
On a blockchain network, users can deal with their peers in a secure environment without going through an intermediary. By bypassing middlemen, DeFi reduces costs, making loans more affordable and increasing deposit rates.
Furthermore, transactions are instant and secured by a blockchain. DeFi protocols treat everyone in the same way, essentially democratizing finance and reducing the inequality and unfair power that banks and financial institutions hold today.
DeFi looks set to play a primary role in the evolution of finance by 2030. But before then, DeFi must evolve. The race is on to build a sturdy infrastructure to support TradFi’s transition into DeFi.
On The Flipside
- DeFi protocols have suffered major hacks in 2021, undermining their security
- Over $400 million have been lost to DeFi hacks in 2021, with the likes of Poly Network, DAO Maker, and PancakeBunny falling victim
What DeFi Needs to Do Before Mainstream Adoption
Before decentralized finance can fully take over traditional finance, the industry will need to become fully regulated. The lack of regulation over the industry makes it impossible for regulatory agencies like the SEC to provide recourse in cases of hacks.
Speaking of hacks, DeFi protocols would need to improve the security of their networks. So far in 2021, DeFi hacks have accounted for 76% of major crypto hacks. Over $400 million have been lost to DeFi hacks in 2021.
The lack of regulation in the crypto industry allows cybercriminals to thrive either by hacking less secure DeFi projects or carrying out rug pull scams. This is why we are witnessing an increasing push from regulatory agencies to control the sector.
Why You Should Care?
Growing from a thing of curiosity, decentralized finance now challenges existing financial systems and looks on course to revolutionize the industry. By 2030, DeFi could increase access to financial services and change how money will be used.