What Is DeFi and Why Do We Need It?
Blockchain technology has been touted as the next massive technological advance in the finance sector. Not only that, it can also bring an important breakthrough for independent innovation of core disruptive technologies and industrial transformation. The application of blockchain technology has already extended to digital finance, the Internet of Things, intelligent manufacturing, supply chain management, digital asset trading, and others. The chain storage structure of blockchain and cryptography ensures user privacy, along with prevent data from being tampered with. Altogether, these blockchain technologies pivot for instilling decentralized finance (DeFi) or open finance movement.
The term originates from an August 2018 Telegram chat between Ethereum developers and entrepreneurs including Inje Yeo of Set Protocol, Blake Henderson of 0x and Brendan Forster of Dharma. It refers to the transition from traditional, centralized financial systems to peer-to-peer finance enabled by decentralized technologies built on the public blockchain. It effectively eliminates the intermediary (middle man) that many of the finance-focused apps and platforms employ. Thus, providing major efficiencies and cost savings in the long run. DeFi helps expand the value of cryptocurrency in financial sectors like borrowing and lending, stocks, bonds, and other tradable assets, asset storage, insurance, and more. DeFi based applications tend to be more transparent, less susceptible to human failings. Since it offers easy accessibility, censorship resistance, with increased security and auditability, DeFi is becoming popular in the finance community.
The best part of decentralized apps (dapps) is that once a smart contract is deployed to the blockchain, DeFi dapps can run themselves with little to no human intervention. With DeFi, anyone with an internet connection and a smartphone could access financial services and use the dapps.
Benefits for Common Mass
It’s highly expensive for people to send money across borders in the current system as the average global remittance fee is 7%. Through decentralized financial services, remittance fees could be below 3%. This can mean the availability of stock trading and loans accessible to the masses, regardless of a person’s economic circumstance. Further, DeFi platforms can connect borrowers with lenders, thus eliminating the credit check process, while applying for loans.
According to a report published by DappRadar, first reported on by Decrypt, the total value locked in the decentralized finance space surged 380% from the end of Q2 2020, and is expected to reach $10 billion by the end of the third quarter of the year. It also mentions that 96% of the DeFi transaction volume is based on the Ethereum network. The reason why Ethereum is the preferred platform for DeFi dapps is that the Ethereum network allows conditional checks before executing a transaction. It also provides developers with the ability to enable a transaction when certain conditions are met.
Need for Interoperability
Meanwhile, Ethereum’s composable software stack ensures that DeFi protocols and applications are built to integrate and complement one another, otherwise termed as interoperability. This addresses the main problem of DeFi, i.e., when a transaction or a smart contract is initiated on one blockchain, it couldn’t be transferred to a completely different blockchain in the network. Interoperability is crucial as the lack of an interoperable solution can disrupt the mass adoption of DeFi architecture. This, in turn, can make the blockchain technologies ineffective for their true purpose. By warranting interoperability, users can share, view, and access information across the blockchains in the network. This free-flow of information would magnify one’s reach and influence irrespective of which blockchain system one uses.
As DeFi offerings are expanding and growing with time, its future looks promising and could show strong progression over the next few years. And with that, it will drive us to a financial world of global accessibility to decentralized financial services, safer transactions, and lower transaction costs.