DeFi: Disrupting the Financial Ecosystem

With the evolution of the crypto space, Decentralized Finance (DeFi) has erupted into a billion-dollar industry, sparking a wave of global disruption. The DeFi movement is driven by the vision of a financial ecosystem that - instead of a central authority like banks- is controlled by the users itself. The benefits of this next generation of ecosystem are that it's open, flexible, fast, and transparent.

This model allows anyone across the world to access a whole set of financial applications without requiring an intermediary. Though DeFi dates to 2016, it is only in 2021 that the concept has been co-opted by a diverse community ranging from professional speculators to institutional investors. Close to $50 billion has been poured into different DeFi protocols this year. But why is everyone jumping on the DeFi bandwagon?

DeFi is A Sustainable Alternative

Undoubtedly, traditional finance is outdated and needs to change the way it identifies individuals, reduces the cost of transactions, and appeals to new markets. But, looking at the recent developments in and around the space, these changes may not come through anytime soon.

As the world explores better opportunities, DeFi seems like a viable alternative. It enables borrowing, lending, depositing funds into a savings account, and trading complex financial products - all in a permissionless manner. Take, for example, Compound, a DeFi protocol that allows users to take out loans at low interest rates, as well as earn interest on the funds lent to its liquidity pools. Subsequently, many DeFi platforms have come up lately, which caused the value of assets in DeFi to surge.

Due to easy access, DeFi has arguably become a sought-after solution for emerging economies with limited access to traditional finance, potentially offering banking to the unbanked or hard-to-bank. Moreover, it offers access to credit, exchange, and investment opportunities to everyone, irrespective of the jurisdiction. 

In addition to providing an alternative to the outdated financial system, DeFi presents a permissionless environment where users are in control of their finances. Additionally, it offers benefits like:

1. Time and Cost Efficient:   DeFi removes the middlemen from key financial activities, thereby making transactions much more affordable. For example, transferring a million dollars in Bitcoin costs only about $24 dollars. Also, the transaction can be completed in 10-15 days. (Note: there are solutions (like Bitcoin Latinum) working to reduce the fee to $2 to $4 and the completion time to a few seconds. On the other hand, a similar transfer through banks would take hundreds of dollars and several days. 

2. Decentralized: Unlike traditional systems, DeFi isn’t controlled by a single entity. All transactions are recorded across participating nodes, which verify each transaction and ensure that no one is “double-spending” their cryptocurrencies.  

3. Quick and Permissionless Operations: Before DeFi, taking a loan could take months due to complex verification processes. Today, a user can take out a loan with just one click. However, DeFi is still to address the overcollateralization concerns.

The Future of DeFi

While no one can predict DeFi’s future, it is evolving rapidly. Developers are exploring new services, business models, and combinations of different DeFi protocols. Tools are being built to simplify the user experience. Services are moving to decentralized governance of protocols.

As the space matures and more development takes place, we can see DeFi involving composition of decentralized applications (Dapps) and financial primitives as “money legos. However, in addition to creating new financial instruments and services, DeFi composability will also bring new risks like impermanent loss, flash loan attacks, and rug pulls. Moreover, the DeFi space is unregulated, which makes it prone to hacks and scams.

Nonetheless, DeFi can turn out to be very rewarding - low interest rates, high returns, near-zero transactions, and much more. It just requires right regulations and understanding of risk obsolescence.