Decentralised Finance (DeFi) aims to address the current limitations and failings of many of the existing centralised financial institutions and can be achieved in fours ways:

  • disintermediation (removing the need for middlemen using smart contracts); 

  • not being reliant on single points of failure - having a decentralised system minimises corruption; 

  • distributed ledgers/databases cannot be easily modified in order to ‘cook the books’;

  • reduction in the cost of transactions - due to transactions being digital (and invariably automatic), therefore no need for human intervention.

Total value of DeFi sector

A close up of a map

Description automatically generated

Source:DeFi pulse

While cryptocurrencies have given the ability to store and transfer funds in order to create a decentralised financial system, there is also the need to be able to invest, lend, borrow and earn interest from assets. Subsequentially, the demand for these types of services has led to the creation of decentralised apps, more commonly known as ‘dapps.’

On Yavin, CEO of Cointelligence (who has recently written a book about DeFi), maintains, “DeFi has the potential to completely disrupt the financial system, on top of the disruption caused by cryptocurrency. Unlike today’s completely centralised financial institutions, DeFi could give individuals full control of their own funds”.  The Cointelligence book gives an explanation about the basics of Blockchain, tokens, DeFi as well as listing a range of additional reading and sites from where readers can get more information, including:

  •  - “a media outlet and analytical services provider for the DeFi community, aiming to inform, educate, and connect the community as the definitive source of news dedicated to decentralized finance space”;

  • DeFi Pulse - “a site where you can find the latest analytics and rankings of DeFi protocols. Our rankings track the total value locked into the smart contracts of popular DeFi applications and protocols”; 

  • DeFi Telegram - where DeFi projects can be discussed. 

  • - which offers more information on DeFi loans. 

DeFi has grown in just the last six weeks, from $1billion to $6 billion! With the ability to earn up to 11% p.a. by investing in US$ via a $Stablecoin (compared to earning practically 0% holding US$ in a bank), it is easy to see why this sector is attracting so much interest and capital.

However, there are plenty of obstacles in the way before we see mass adoption, and DeFi can undoubtedly make in-roads into the massive derivative market which is estimated to be $12+ trillion, compared to the Foreign exchange (FX) market at $6.6trillion. The main challenges facing DeFi are:

  • moving assets between different Blockchains and, in any event, most assets (i.e. equities, property, commodities, bonds, currencies etc) are not even available in a digital format;

  • ensuring that the code in-bedded in smart contracts is secure from hackers;

  • a lack of international regulations and legislation as, indeed, smart contracts in some jurisdictions are not even recognised. Also, there is currently no global agreement relating to KYC/AML;

  • the compatibility with traditional financial markets and engaging with DeFi and crypto assets (with their hot and cold wallets, private keys passwords etc) does not offer an easy user experience for those new to this market. However, Wedefi and are good examples of how this topic is being made more accessible and understandable.

Nevertheless, caution is required as was seen by the recent loss suffered by Yam token which fell from $57million on 13th August 2020 to $0 in two hours as an error was discovered in its smart contract! Examples such as this support Vitalik Buterin, co-founder of Ethereum, who is concerned that users of DeFi are potentially underestimating its risks, with DeFi damaging the long term potential offered by Blockchain.