Will decentralized finance reshape the future of finance?
Before we dive into DeFi's possibilities and start explaining why Defi is the future of finance, let's review what DeFi is.
What is DeFi and how does it work?
DeFi stands fordecentralised finance, a financial system that runs on a decentralized network of computers. DeFi is a multitude of financial technology tools that are built on a blockchain, used for borrowing, lending, and other banking services. These products and services are accessible to anyone and eliminate the need for a financial middleman such as a bank or a broker. It was created as an alternative to traditional financial services. The world of decentralized finance comprises non-custodial financial products and is built around highly-experimental, highly-lucrative crypto projects.
DeFi is built on the blockchain -- a decentralized, immutable, public ledger on which Bitcoin is based -- that enables all computers (or nodes) on a network to hold a copy of the history of transactions. The idea is that no single entity has control over, or can alter that ledger of transactions.
Decentralized Finance (DeFi) has experienced tremendous growth since mid-2020.
Examples of DeFi
Among the most popular projects are lending protocols Aave, Maker, and Compound. These protocols let you borrow cryptocurrencies instantaneously —and often in large amounts, if you can prove you can pay back the loan in a single transaction. You can also earn interest from lending out cryptocurrencies.
Decentralized exchanges are another popular type of DeFi protocol. Uniswap is by far the largest and well known decentralized exchange. In August 2020, the daily trading volume on Uniswap hit $426 million, surpassing and challanging centralized exchanges such as Coinbase, on which traders exchanged $348 million worth of cryptocurrencies. Others include Balancer, Bancor and Kyber. The project 1inch aggregates all of the decentralized exchanges on their website.
While Bitcoin is a decentralized digital currency that operates on its blockchain and is used mainly as a store of value, DeFi is a concept that describes financial services that are built on public blockchains, Bitcoin and Ethereum, for example, enable users to earn interest or borrow against their cryptocurrency holdings while DeFi is comprised of a variety of applications related to financial services such as trading, borrowing, lending and derivatives.
The possibilities of decentralized finance and its future
Decentralized finance has a lot of potential and provides many opportunities. One thing that stands out is that it removes the need for financial bureaucracy. After the not-so-distant TerraUSD (UST) crash - a stablecoin pegged to the US dollar the DeFi sector has even more concerns for its future. The crash bankrupted many investors and dragged down the entire crypto market: over $400 billion in value was wiped when it comes to crypto market capitalization.
However, even with such a significant collapse in the crypto market, cryptocurrencies still have the advantage of becoming the primary digital payment method, as they maintain the variable of privacy. DeFi provides the most secure payment channels. In DeFi, liquidity is provisioned and aggregated across many cryptocurrencies to enable decentralized trading,creating pools of liquidity that can be drawn instantly, rather than having to match a buyer and seller at the time of the transaction.
Whether decentralized exchanges, lending, borrowing, or through insurance products DeFi is evolving and expanding swiftly to mirror the traditional financial services ecosystem. This new form of technology may eventually impact the future of centralized finance entities, with DeFi potentially being seen as a cheaper, quicker, and more relevant alternative.
Though DeFi isn't bullet proof yet and can carry some risks, it offers an entryway to secure transactions. Of course, there are some concerns on the side of regulators when it comes to money laundering and illegal payments, however they are offset with unlimited opportunities for the finance world.