Decentralize Finance, an emerging intersection of blockchain technology, cryptocurrencies, and financial services, has become a buzzword in recent years. The total value of digital assets locked in the space rose from $700 million in December 2019 to around $200 – 220 billion in January 2022, remaining relatively stable as crypto prices fell. This article discusses decentralized Finance, what it is, and its impact on the cryptocurrency sector in general.
What is DeFi?
Decentralized Finance (DeFi) refers to several applications in the blockchain and cryptocurrency sectors that aim to disrupt the financial industry by eliminating intermediaries. The idea behind DeFi is the technology behind cryptocurrencies like Bitcoin, where copies of the history of transactions are held by numerous entities and not a single central source. This differs from the traditional centralized systems where human gatekeepers control systems and can limit the speed and intricacies involving transactions. DeFi distinguishes itself by expanding the use of blockchain to involve complex financial use cases.
DeFi applications imitate traditional financial systems, including trading, credit lending, and asset management. In DeFi, blockchain-based technologies replace the conventional need for financial third parties like banks, lending institutions, and advocates so users can enter into transactions directly via software protocols known smart contracts. Users don’t transact under their names but rather use blockchain addresses, described as pseudonyms, which are publicly visible.
Reasons behind the Success of DeFi
One of the primary goals of cryptocurrencies, and DeFi, in particular, has been to encourage financial inclusion to ensure that over 1.7 billion unbanked people worldwide have access to benefits enjoyed by people with bank accounts. To ensure that the people previously excluded by traditional finance systems could participate in financial issues, DeFi leverages blockchain technology to enable anyone with a smartphone can enjoy financial services. Among the reasons DeFi became so successful so soon include the following:
Easy to Use: While crypto and DeFi may have looked like intimating sectors at the beginning when they were the domain of only those that were tech-savvy, things have changed now so that users can now exchange fiat currency into crypto and vice versa via decentralized exchanges and gain access to high yields offered by DeFi platforms.
Open to All: DeFi platforms initially concentrated on individual investors, but as the sector continues to grow, it has designed products that have seen institutional investors access the decentralized market. Some DeFi platforms maintain high levels of oversight while remaining compliant with government regulatory and security requirements.
Sky-High Returns: Among the most appealing attributes of DeFi is the amount of yield that investors receive. Since all transactions are peer-to-peer and there are no expensive intermediaries, participants, especially lenders, take the total yield and don’t share their returns with gatekeeping third parties.
Speed and Reliability: DeFi replaces gatekeepers with smart contracts, eliminating manual validation and possibilities of human error during processing and verification. Smart contracts make DeFi processes faster and more reliable than traditional financial service procedures. Since it’s available 24/7 as long as there’s an internet connection, investors aren’t restricted to trading during the hours when banks open and close their doors.
New Investment Avenues: Previously, yield farming was only accessible to large institutions and wealthy individuals. However, the introduction of DeFi has enabled anyone who owns even the smallest amount of cryptocurrency to join these lucrative markets and generate passive income.
The Impact of DeFi on Cryptocurrency
The first cryptocurrency was designed purely as a decentralized alternative to traditional currencies, but money is only a simple instrument within the modern financial industry. The exponential growth of DeFi applications, most of which run on the Ethereum blockchain, has stimulated activities regarding developing “efficiency-oriented tools” that run on top of Ethereum. The result has been faster, cheaper, and highly-scalable blockchains.
DeFi’s noncustodial smart contracts have eliminated the need for intermediaries from complex transactions by introducing code that locks tokens in a user’s digital wallet until certain conditions are met. The result has been the introduction of new decentralized exchanges that are steadily grabbing the market share of erstwhile established centralized exchanges. Moreover, DeFi’s fully automated nature has facilitated the creation of new financial instruments within the crypto sector. A good example is “flash loans,” in which users can take out funds, convert or trade them, and repay within the same transaction.
That cryptocurrencies are no longer a fringe asset is an open secret, as several banking institutions have been looking for ways to integrate them into their existing systems. By introducing financial inclusion, DeFi has the potential to popularize significantly or support cryptocurrency adoption. Besides promoting crypto as the foundation upon which it is built, DeFi is using crypto to reshape how people manage their finances by showing you no longer require an intermediary like a bank to deal with money in a way that blockchain already does.
The Future of DeFi within the Crypto Sector
While it may be too early to judge the true impact of widespread DeFi adoption on the cryptocurrency space and traditional Finance, it’s already apparent that consumers are decentralizing their financial issues. Decentralizing one’s finances via DeFi has created an environment that has brought attitudinal and behavioral shifts toward the entire cryptocurrency sector. Consumers have since learned that beyond trusting their “primary banks,” they can safely supplement banking services using Fintech firms or digital wallets and manage financial relationships via a smartphone.
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