One of the biggest applications of blockchain technology is decentralized finance, or ‘DeFi,’ which is dedicated to reinventing the financial system using decentralized and automated technologies. DeFi is the spiritual successor to Bitcoin’s purpose, allowing crypto holders to access financial services such as loans, savings, trading and even advanced financial instruments.
The greed and incompetence of the traditional financial system that resulted in the 2008 financial crisis led to the creation of Bitcoin and blockchain technology, but Bitcoin lacks the financial services that the financial system provides, and there is no way to build those services without relying on centralized services. infrastructure. So while the invention of Bitcoin was an impressive feat, it has since been enhanced by blockchain smart contracts developed by Ethereum, which enabled blockchain programmability and paved the way for Web3 blockchain-based internet apps, along with thousands of cryptocurrencies and NFTs. Today.
After Ethereum was distributed in 2016, it didn’t take long for developers to start creating financial services for cryptocurrencies, leading to the rise of ‘DeFi’. Investopedia explains that DeFi provides financial services for cryptocurrencies, but is still an emerging industry. Instead of relying on banks, DeFi users act as their own banks by approving transactions, protecting their assets and using their crypto in DeFi apps. DeFi is a very broad category that spans entire asset classes and many types of Web3 apps. Many DeFi apps use stablecoins (stable-value cryptocurrencies), which have become the lifeblood of DeFi due to their use of crypto lending/lending platforms such as Aave and their utility as a payment method. In addition, DeFi is known for its decentralized exchanges, or ‘DEXs’, such as Uniswap, which allow users to trade between any two cryptocurrencies built on the same blockchain. Although not explicitly DeFi, non-fungible tokens, or “NFTs”, have found use in NFT lending/borrowing apps as well as by non-NFT DeFi apps that use them to represent crypto deposits, and NFT -marketplaces like OpenSea have been a staple of the industry for years for their role in providing NFTs with value through trading.
DeFi is a new technology, and very unregulated
While many ‘blue chip’ DeFi protocols are considered safe to use (especially those mentioned above), DeFi is a wild west of new ideas and experimentation, much of which explodes due to unforeseen complications or gets hit by hackers or crypto- phishing attacks. As a result, DeFi has earned a reputation as a gambler’s paradise, although DeFi risk depends entirely on the user’s choice and understanding of the concepts they are working with. DeFi has crossed paths with regulators before, who are not amused by the complete lack of KYC (Know Your Customer) and AML (Anti-Money Laundering) policy compliance that all other financial services must adhere to, as well as the inability of DeFi apps to follow such guidelines because of their immutability.
According to DeFi Pulse, there is currently (Sept. 2022) a staggering $26.3 billion in assets locked up in DeFi smart contracts, and in October 2021, the highest value locked up was $45.5 billion. DeFi is still a niche industry with many “learning experiences” ahead of it, but it could easily become a multi-trillion dollar industry in the future, given its utility and broad scope. While DeFi could theoretically pose an existential threat to the existing financial system, the two systems will likely coexist and forming symbiotic relationships. As Fireblocks reported, Aave has already jumped on this idea with Aave Arc, a permission-lending pool for institutional clients. It seems inevitable that banks will eventually have their own smart contracts to send and receive stablecoins from the blockchain.
DeFi is still a nascent industry striving to create financial services for cryptocurrencies and blockchain assets, but it stands to become one of the most powerful industries in the world over the next several years. Currently, it is a playground for gamblers, geeks, fraudsters, hackers and visionaries alike, but many DeFi apps have proven their durability and security, and with better user experience, DeFi will become a major financial technology that everyone uses in one way or another.
Sources: Investopedia, Aave, Uniswap, OpenSea, DeFi Pulse, Fireblocks
