In just a little over a year, the total value locked (TVL) of decentralized finance (DeFi) has increased from $21 billion in January 2020, to over $200 billion a year later. That means that over $180 billion dollars made its way into cryptocurrencies and blockchain projects in less than a year.
These massive investments were driven primarily by DeFi and the many projects it consists of. So what exactly is DeFi? And why is so much money being invested in it?
DeFi is an acronym for “decentralized finance,” although it’s often referred to as “open finance”. By allowing people and organizations to perform financial transactions using developing technology, decentralized finance eliminates intermediaries or central authorities. Blockchain is the perfect platform for this kind of thing as it provides a fast and secure way for people to transact with one another.
Decentralized finance allows anyone to borrow, trade, lend, and do plenty of other things using cryptocurrency and cryptocurrency tokens. It does this through the use of decentralized applications (dApps) built directly on top of a blockchain. Since blockchains are essentially databases supported by thousands of different machines, these networks are incredibly resilient and can’t be easily manipulated or changed.
Decentralized finance uses this technology to abolish centralized finance models by allowing anybody, regardless of who or where they are, to access financial services. Through personal wallets and individual-centered transactional services, DeFi solutions enable its users to exercise more anonymity over their finances.
DeFi is a financial concept first based on the Ethereum blockchain, which is accessible to anyone that has access to the internet. DeFi is a permissionless program, which means it is neither managed nor controlled by a central authority like a bank or government. Cryptography, smart contracts, and blockchain technology are all features of cryptocurrencies that allow this decentralized finance system to exist for the worldwide community to use.
Ethereum makes use of Solidity, a powerful smart contract programming language that permits all of the functionality required by financial contracts to be integrated with the program code for DeFi applications. Several other blockchains, such as Avalanche, Terra, Fantom, and others, now contend with Ethereum to run DeFi apps, but Ethereum is still the largest blockchain by far.
MakerDAO, was the very first DeFi project, and it was launched in 2015 on the Ethereum network. MakerDAO lets anyone use smart contracts to lock ETH and get DAI, a stablecoin pegged to the US dollar in return. DAI is frequently utilized in MakerDAO’s Oasis savings system, which basically creates a decentralized bank. Oasis built a loan and borrowing marketplace for its members using stablecoins and smart contracts.
Blockchains are the underlying technology in decentralized finance. Decentralized applications (dApps) are built on top of blockchains through the use of smart contracts. These smart contracts are essentially pieces of code that can run and operate on the blockchain. This allows the creation of complex platforms and programs that can be run entirely on the blockchain.
Through the use of these dApps, blockchain users have the ability to lend and borrow their cryptocurrencies, deposit cryptocurrency into a liquidity pool in exchange for fees, and countless other things. Essentially, DeFi has allowed developers to expand what’s possible with cryptocurrency. Now cryptocurrencies aren’t just seen as an object of value like any other currency. They can also be used as financial tools, governance control, and much more!
The purpose of DeFi is to establish an accessible, trustless, and permissionless financial system. DeFi has seen a lot of investment and development, and everyone needs to be aware of what’s going on in this market. The innovation and technology in DeFi continue to expand and make improvements to blockchain and cryptocurrency as a whole. As more projects and developments are introduced, we are able to expand what is possible within the decentralized world.
A major feature that makes bitcoin so difficult to destroy is its decentralization. Since no individual party is in control, it’s practically impossible for anyone to go haywire and violate the virtual coin’s regulations. Similarly, even if a government tries to stop a number of computers from enabling the bitcoin network, the digital asset will continue to operate since other computers connected to the network keep a complete shared ledger of all the transactions and can remain operational. This makes bitcoin, and by extension, cryptocurrency and DeFi incredibly valuable.
Decentralized finance has had a significant impact on the way banks work and has triggered changes in the financial ecosystem as a whole. For the best of reasons, there are many opposing viewpoints on decentralized finance right now. Some individuals see DeFi as a revolution and an opportunity, while still others see it as a sham.
1. Increased Accessibility
The conventional way to get a loan is to use a bank and go through the process of applying for a loan. However, this is generally time-intensive, strenuous, and approval isn’t guaranteed. Even in the middle of the night, you may receive a loan with DeFi with only one click. That has completely changed with DeFi. Using a dApp, someone could quickly get a loan without the need for approval or a long process. This not only speeds up the process, but also makes it more accessible for those that may not be able to get a conventional loan.
2. Human error and mismanagement are no longer an issue.
Everything on the blockchain is programmed and automated, so there’s no need for any human input other than your own. This completely eliminates any potential issues or problems that could arise from human error. Since everything is automatic, it also makes it much easier to predict the outcome and estimate potential profits, losses, and fees.
3. A More Balanced Financial System
According to top Economists, the effects of the worldwide COVID -19 pandemic were three times worse than the financial crisis of 2008. It’s become extremely apparent that the traditional financial system is quite vulnerable to these types of situations, as shown by rising inflation and the economic difficulty many people face.
On the other hand, DeFi isn’t dependent on any particular companies or organizations. Once developed, decentralized applications simply run on the blockchain without the need for support. This makes them incredibly resilient and reliable as they aren’t susceptible to bankruptcy, or issues within the economy.
4. Permissionless Operations
With the current centralized financial system, practically every financial transaction requires permission from an intermediary. Even though you own all of the money in your bank account, you must wait for bank approval in order to take a penny from your account. However, blockchain provides the ability to be your own bank. By using a cryptocurrency wallet, you can deposit, withdraw, invest, loan, or borrow within seconds. You have full control of your money, no approvals needed but your own.
If the blockchain hosting a DeFi project is volatile, the project will automatically acquire the host blockchain’s instability. For example, there are plans for the Ethereum blockchain to transition from PoW to the new Eth 2.0 PoS algorithm, and any mistakes made during that transition process could pose new hazards to DeFi projects.
DeFi projects are highly dependent on the blockchain they’re hosted on. That’s because the blockchain is responsible for all of the transactions that go on. So if a blockchain suddenly has an influx of traffic, it could potentially get bogged down. This is what has happened to the Ethereum blockchain, resulting in longer transaction times and big fees.
Other blockchains have improved upon this design to ensure that they can handle more transactions and properly respond to a fluctuation of activity. However, this doesn’t change the fact that dApps are still quite reliant on the accessibility of the blockchain.
Decentralized finance continues to grow and continuously expand what’s possible with cryptocurrency and blockchain. While cryptocurrency offers major advantages by itself, DeFi exponentially increases its value and the benefits users get.
Currently, DeFi provides many capabilities including borrowing and lending cryptocurrency, staking tokens to earn more, trading and exchanging tokens on the blockchain, and numerous others. But its true power comes from the fact that it’s an ever-expanding ecosystem that’s fueled by the ingenuity and innovation of developers across the world. The sky is the limit when it comes to what’s possible, and that’s what makes DeFi the future of finance.