Earlier this year DeFi hit the headlines with a first billion dollars being locked up in the space. A revolutionary innovation that is disrupting the financial industry, but still many outside the crypto space probably haven’t heard of DeFi.
Bitcoin really is the first application of decentralized finance, but the term DeFi is being used for a much wider approach to the decentralization of the financial industry, and is being powered mostly through Ethereum smart contracts.
It really could become Ethereum’s killer dApp, and as we see with its rapid growth, DeFi is already starting to disrupt the financial industry.
What is DeFi?
Decentralized Finance, or as most call it DeFi, is what it says on the tin: finance that’s decentralized. Bitcoin was the first application of DeFI, but as stated earlier, the DeFi movement is thought of as what’s being built on Ethereum and other smart contract platforms.
The main objective of the DeFi space is to open traditional financial services to everyone. We’re already seeing this, and the growth of the space has been fantastic.
The DeFi dApps of today are replicating many of the services that we are used to through traditional banking. Lending, borrowing, investment, wealth management, and insurance are all industries that are being built into smart contract powered DeFi space.
But of course, there are no banks, or insurance brokers involved. Not in the traditional sense anyway. It’s all being done through peer-to-peer a network of interested people and institutions.
In fact, you and I can become a lender, and earn interest from somebody wanting a loan. It’s all collateralized loans for now, but things will evolve and credit based loans will become a thing in the DeFi space.
DeFi Is On an Upward Trend
Although the DeFi market cap topped at $1.23 billion on February 15th, before crashing along with everything else due to the coronavirus shutdown, the long-term trend is still very positive for DeFi.
With today’s market cap at just under $813 million, it’s a staggering amount considering, the DeFi space has only been a thing for just over two years. And don’t forget it’s all done without the need of a bank account, without a middleman, and the customer is always in possession of the underlying investment.
The majority of the investment is in DAI, which is Maker DAO’s stablecoin, built on the Ethereum blockchain. Not far behind DAI is ETH, and with over $400m locked up in smart contracts, it’s an indication that as the space grows, it will elevate and stabilize the price of ETH.
What Does DeFi Offer That’s Different Now?
As stated earlier, DeFi offers things such as collateralized borrowing and lending etcetera, but all of this is possible in the legacy financial system.
DeFi is decentralized finance, and unlike the legacy financial system, it does everything through a decentralized peer-to-peer network, and one that can be audited by anybody.
Decentralization in the purest form offers censorship resistance, meaning nobody can stop or delete anybody’s transaction. And Ethereum allows for relatively quick and low-cost transactions, and automated smart contracts eradicate the need for middlemen.
Unlike the traditional sector, it offers worldwide participation regardless of social status, meaning anybody with a connection to the Internet can now easily be connected to a new and truly global economy. And every person involved is basically his/her own bank, with complete control of their finances.
As well as this, nobody trusts their insurance company. When insurance is built into smart contracts, it will not only minimize costs for insurance companies, but with the self-executing smart contracts, it will also bring trust back to the insurance industry.
DeFi’s Network Effect Will Propel Its Growth
At the core of DeFi is its network effect, and the growth of the network effect will ensure its place in the global economy.
The banking industry is a shut off industry. Even the banks can’t really work together, as it’s too expensive to man, and they don’t really trust each other.
With DeFi we are already seeing a combination of different layer 2 and 3 projects being built on Ethereum. These applications can seamlessly work together or separately as they please. And this will help each dApp grow, and the DeFi economy.
DeFi has so much promise, but it needs to overcome a few hurdles first. For a global economy it has low liquidity, and the UX is ok for geeks but for the average person it’s too clunky. These need to be sorted.
Then there’s government regulations. This is most definitely holding DeFi back, so once there’s more clarity from governments, it will enhance trust from institutional players and the space will naturally grow.
But probably the biggest thing that is stifling the growth of the DeFi space is Ethereum’s inability to scale. Of course this is being worked on, and Ethereum 2.0 is set to be rolled out over the next couple of years.
A global peer-to-peer economy needs immediate settlements, at scale. And once Ethereum can offer this, it will usher in so much innovation into the DeFi space.
DeFi is a truly global economy. An economy that is being formed outside the fiat and banking economy, and one that is disrupting the financial industry. It has grown at fantastic rate in just over two years, and will continue to grow as Ethereum grows.
Author: Tommy Limpitlaw