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The world is facing a pandemic, and our global financial infrastructure has been put to the test. But even in the face of multiple ground-shaking events, decentralized finance (DeFi) managed to grow. In these dire times, DeFi’s blockchain-based technology proved to be a savior for many, revolutionizing the finance sector.
In simple words, DeFi is a blockchain-based technology that is an alternate form of finance. Unlike conventional finance, it does not depend on central financial intermediaries, thus effectively cutting the cost a great deal while simultaneously increasing the privacy and security of a transaction. This is done by utilizing the smart contracts feature on blockchains, generally Ethereum.
As of July 2021, DeFi’s market cap is almost $80 billion and is expected to rise more in the future. The visible growth and support of DeFi can also be tracked in the ever-increasing Total Value Locked (TVL) in the DeFi world.
After global financial systems collapsed in 2008, governments and central banks of major economies made a commitment. They decided that never again would they allow the banking system to threaten our economic and social well-being. Since the 2008 crisis happened because of the extreme risk-taking by banks, the finance sector grew to play it safe by being less experimental and rejecting any transformation that would require changing the whole financial framework.
The global pandemic was again a fact check for the banking sector when the socio-economic life of many was wrecked. They now need to make a sustainable and robust recovery from the disastrous economic effects of Covid-19.
Related: What’s Holding DeFi Back (and How to Fix It)
The great reset
Amid the ongoing pandemic, in June 2020, the World Economic Forum(WEF) came up with a program called “The Great Reset.” Financial systems realized that they need to change the global economy from its fundamentals. The notion is that there is a need for society to acknowledge the economic issues caused by the Covid pandemic and anticipate further challenges the world might face. Blockchain can help finance a great reset, and DeFi can lead this revolution.
DeFi is a blockchain-based ecosystem that puts the community first and provides financial services built on distributed networks that do not have a central authority. That means no individual governs the organizations; rather, they are governed by the community members.
In current financial systems, banks play an imperative role. They are the only major players and are always in a position of power. DeFi is a community-managed program.
Defi strives to build a more fundamentally functional financial landscape enabled by blockchain technology. With the adoption of blockchain technology, the banking system will benefit from the following three aspects the most:
Related: Getting Drawn Into DeFi? Here Are 3 Major Considerations
A new and secured digital world
One of the secondary effects of Covid is that people got accustomed to online transactions and select the most convenient way for their banking and transaction needs. Financial institutions are looking to cut costs in every way possible; switching their operations through digital platforms can effectively help them cut costs.
In the long term, DeFi is here to stay and will make some significant changes in the finance sector. A lot of activities are already going on in the crypto space that is related to DeFi. For example, China is releasing its Central Bank Digital Currency (CBDC), the digital Yuan. European countries are following the trend.
Early applications of DeFi
Even though DeFi is still in its infancy, DeFi has displayed its potential in many ways. Financial banking services, alternative savings, and P2P lending platforms are just some of the mainstream applications of DeFi, where investors and enthusiasts have locked billions of dollars supporting the technology.
While a blockchain-based decentralized system can usually process transactions faster and more securely, price volatility associated with these DeFi tokens is an issue that has held back mainstream adoption. Hence, stablecoins come into the picture. Stablecoins are digital coins pegged to a real-world currency such as the dollar or yen.
With Defi, stablecoins are also growing; out of the top 10 cryptocurrencies right now, three are stablecoins with a combined market cap of around a trillion dollars. Stablecoins gives an ecosystem the transaction of cryptocurrencies with the stability of a fiat.
DeFi apps also offer users a way to store their money outside of traditional institutions, such as banks, and farm them to supply dollars to liquidity pools in the blockchain.
Another important application of these newfound blockchain-based technologies is decentralized exchanges, which aim to give both the security and speed that centralized exchanges can not provide.
As mentioned above, DeFi is still in its infancy, and hence there are some challenges that the technology is facing and needs to be countered for further adoption.
There is a constant security threat in some projects that are not built properly; in the past, there have been instances where hackers got away with millions of dollars worth of cryptocurrencies in a Defi protocol exploit. In many cases, the protocol itself also turns out to be a scam, and therefore, there is a visible skepticism for DeFi.
The potential of DeFi is undeniably huge, and hence taking the security issue will undeniably be important for both potential adopters and current DeFi leaders. Many developers are unable to meet the sky-high demands of users and hence are using third-party monitoring tools, and in the future, the demand for security services in this field is going to see a steep increase. Concepts like smart contract insurance and stablecoins are protecting users from both volatility and cyber threat.
While all new technology comes with its challenges, it will be exciting to see the innovative ways we will be using blockchain for the betterment of society and the whole financial system.
Related: How DeFi Will Reshape Financial Services