DeFi stands for “decentralized finance,” and is an umbrella term for a variety of financial applications in digital assets or blockchain. DeFi is interesting as it extends the use of blockchain from simple value transfer to more complex financial use cases.
The core of DeFi lies in the technology behind the digital currency, bitcoin, which allows several entities to hold a copy of a history of transactions. Hence, it is not controlled by a single, central source. In the early days, conceptually, the idea of DeFi was often called “open finance.” Most applications that call themselves “DeFi” are built on the Ethereum platform, the world’s second-largest digital asset by market cap. The primary reason for this is that Ethereum’s platform relies on smart contracts, which automatically execute transactions if certain conditions are met and hence offer much more flexibility.
From lending and borrowing platforms to stablecoins and tokenized BTC, the DeFi ecosystem has launched an expansive network of integrated protocols and financial instruments. Currently, ~$15 billion worth of value is locked in Ethereum smart contracts, as it provides a wide range of uses for individuals, corporations, and developers. By deploying immutable smart contracts on Ethereum, DeFi developers can launch financial protocols and platforms that run exactly as programmed and that are available to anyone with an Internet connection.
The Rise of DeFi:
In the traditional ecosystem, there is a legal requirement that lenders and borrowers know one another’s identities, for which we have intermediaries. In DeFi, there are no such requirements. Instead, everything is about mutual trust and ensuring privacy. In July last year, the US Securities and Exchange Commission (SEC) made a major shift towards embracing DeFi by approving an ethereum-based fund, Arca, for the first time; a move that was much appreciated by the crypto community.
A second reason for the DeFi surge is that banks and FI’s are getting involved. Many global financial institutions have started to accept DeFi, such as JP Morgan, ANZ and Royal Bank of Canada. Today, many global asset management funds also take DeFi seriously. Most prominent is Grayscale, the world’s largest crypto investment fund.
Moreover, the pandemic has driven global interest rates even lower. In the Eurozone, interest rates are now in negative territory and the US and UK could potentially follow. In this economic climate, DeFi can offer much higher returns to savers. Compound, for example, has been offering an annualised interest rate of 6.75%. In addition to a higher interest rate, holders also get additional Compound tokens, which is an added benefit. With two-thirds of people without bank accounts in possession of a smartphone, DeFi also has the potential to open up finance to them.
Key Advantages of DeFi Ecosystem:
Decentralized finance leverages key principles of the Ethereum blockchain. This allows for increased financial security, better transparency, more liquidity and growth opportunities. Ultimately, this helps to support the development of an integrated and standardized economic system.
