Decentralized Finance, or DeFi for short, has been the topic of discussion in the communities of finance and blockchain lately. Many think that a shift from centralized finance (traditional financial institutions such as banks and hedge funds) to decentralized finance will happen in the upcoming decades, truly disrupting the world of finance as we know it. Others argue that DeFI is just another hype, comparable to the hype of the Initial Coin Offerings (ICO) back in 2017. Is Defi here to stay?
Decentralized finance refers to an ecosystem of financial applications that are being developed using blockchain technology. It aims to disrupt traditional centralized finance by facilitating financial applications and services, on peer-to-peer (P2P) blockchain protocols. This P2P nature eliminates the need for intermediaries and middlemen seen in the traditional finance industry. Previously, these intermediaries, in the form of banks and wealth management institutions, had control over who had access to these financial services. By eliminating these intermediaries, almost anyone with a connection to the internet now has access to a very broad range of financial products. This creates an enormous opportunity for those nearly 2 billion people across the globe that do not have access to basic financial services. Additionally, even for those who have access to basic financial services, DeFi could open the gates to a suite of complex financial services that previously only millionaires and billionaires had access to.
The applications and use-cases of DeFi range from standard lending and borrowing to more sophisticated use-cases such as mortgages, insurance, decentralized exchanges and complex financial instruments like leverage- and options trading.
Despite the potential, we need to acknowledge that the DeFi sector is still in its infancy. There are multiple hurdles to overcome before DeFi can reach its true potential. Some of these hurdles are inherent to the characteristics of a blockchain. Firstly, transactions on a blockhain are (practically) irreversible. This becomes a problem in case of fraudulent and/or money laundering transactions. Secondly, transaction fees on the Ethereum network, the most used DeFi platform, are somewhat high in comparison to other blockchains. Thirdly, the liquidity on most DeFi platforms is relatively low. Liquidity should however increase as DeFi gains more attention.
While DeFi might need some time to overcome these hurdles, it is clear DeFi has the potential to disrupt the Financial industry.
Hi Jesse, good insights into the world of DeFi! I think it will be interesting to see how and if banks will change and innovate to stay relevant. Still, I think many FinTech applications will be more serious competitors of banks. One of the problems I have with cryptocurrencies is that is that the ledgers are fully public. Consequently, if you transfer an amount to my address I will know your crypto address and I can see how much you have. Even if you would create a ‘spending’ and ‘saving’ address, it would be easy to track the ‘saving’ address from the ‘spending’ address. What do you think?