Written by Jonny Fry
Writers linkdin: https://www.linkedin.com/in/jonnyfry/

Cryptocurrencies are as diverse as the real world, but they are all typically powered by the same technology - blockchain. One of the potentially most interesting uses of cryptocurrencies is in the field of decentralised finance (DeFi) as it offers the opportunity to challenge the existing financial services sector and also helps to embrace many of the 1.7 billion people globally who are unbanked. DeFi is termed as ‘decentralised’ because there are no central authorities.

It has disintermediated many of the usual agents, brokers and other intermediaries which are so prevalent in existing financial services. In theory, this means that the public can get the best deals on financial products without having to trade with a third party. In many jurisdictions, governments have actively encouraged ‘open banking’ and the establishment of neo-banks/challenger banks, but DeFi offers the promise of even greater competition for established financial institutions and thus greater choice for buyers of financial products and services.

Source: Twitter

DeFi is a financial application built using blockchain-powered platforms and designed to disrupt the traditional finance world. It is a financial application on open, programmable blockchains and covers activities such as saving, lending, sending money, trading, investing and more. Rather than relying on third parties, DeFi encourages open-source cooperation whilst maintaining security. These DeFi applications are built using cryptographic data bases not relying on having the information stored or maintained at one location or fileserver, which means that they have in-built disaster recovery. Another feature is that by using Blockchain technology, DeFi offers greater transparency for the buyers, sellers and regulators and therefore it ought to, if designed correctly, engender enhanced levels of trust. With adaptation of traditional financial tools to the DeFi world, it is advancing at a fast rate. There is an expectation that other industries will follow suit in the near future.

What DeFi offers 

DeFi products and services are available to anyone who has a digital wallet and an internet connection, no matter where they are in the world. Users can trade and/or move their assets wherever they want, without having to wait for bank transfers or pay traditional bank fees which can sometimes be subject to delays and are very often restricted to standard 09.00 to 17.00 working hours, five days a week. DeFi markets trade 24/7 and are helping to democratise banking and finance by making financial services easily accessible to anyone.

Transactions are public

The Ethereum blockchain is responsible for typically more than 90% of all DeFi transactions, which means every transaction is broadcast to and checked by multiple users. This means that anyone can see what transactions are happening in a very transparent manner. DeFi applications can be a game-changer since they give investors more information than they typically would have had access to. DeFi can also help to ensure that people have access to market leading products and services. 

 

DeFi is secure

With no central authorities, users do not have to worry about the safety of their money because users are always in charge of their capital at all times. However, as with any new technology, there are risks associated with DeFi platforms particularly if smart contracts (which power many DeFi platforms) have not been fully stress-tested against heist and hackers. In 2021, DeFi platforms saw over $10billion being stolen so clearly more needs to be done to address this in order to protect investors in this sector.

DeFi’s uniqueness

DeFi loans are one of the popular applications. DeFi platforms link borrowers with lenders, hence eliminating the credit check process and making the process both more efficient and not subject to intermediaries taking fees or incurring mistakes. The use of Blockchain technology offers the promise of lower counterparty risk, so providing cheaper and faster loans without geographical limitations. Indeed, DeFi is potentially helping to make less relevant those national boundaries which present major challenges for regulators looking to protect their citizens. It is highly likely that there will be users of DeFi applications in one jurisdiction executing transactions but not knowing where the DeFi platform is actually based, which makes it more than a challenge in the event of a claim or problem. 

This inability to know where to go to (and to whom) in the event of a DeFi default problem is juxtaposed to the current regulatory framework which has been built around accountability and senior management responsibilities. Whilst we are all only too familiar with Know Your Client (KYC) in the event when users wish to make a claim, they may well find the DeFi platform is not regulated - nor does it have any insurance. However, in order for DeFi applications to be utilised by institutions, it will be necessary for DeFi platforms to be licensed in order to pass those due diligence checks that traditional financial services forms require. Already there are companies such as Swarm Markets, which is licensed by the German regulator BaFin, making it easier for institutions to use and so trail DeFi applications.

Play-to-earn

The on-line gaming industry has also been quick to embrace decentralised technologies and it has been predicted that GameFi will grow to be worth over $317billion by 2027. GameFi is where players are rewarded for their in-game skills with DeFi coins, having the opportunity to be paid while they play.

Yield farming

Liquidity mining (or yield farming) involves locking up digital resources to generate income (i.e., a yield) which are normally delivered automatically by smart contracts. During the last few years, the DeFi space has grown considerably. According to Finance Monthly: “(DeFi) is booming, with the total value locked – the overall value of assets deposited in transactions – having risen from $700 million in December 2019 to over $200 billion at the beginning of 2022, equivalent to Greece’s 2017 GDP”.

Yet DeFi, is barely three years old, with many of its services becoming mainstream for the crypto community in the ‘2021 DeFi summer’. Lending platforms such as Aave and Compound, together with decentralised exchanges such as Curve and Uniswap, cemented their positions as the market-leading protocols with the first-mover advantage. Some argue that the penetration of DeFi has only just started, and with the resources and talent flowing into this sector it is likely to grow 100x in the next 5 years as it transforms conventional financial services. Arguably, DeFi could foster greater application of Blockchain technology in the financial services sector with the value benefits of immutability, transparency and decentralisation. However, DeFi still fosters challenges it needs to address (such as scalability) and regulation needs to be given the opportunity to catch up with the technology and the decentralised cross- border nature of DeFi.