FinTech

What Is DeFi, And Why Does It Matter Now?

The current high growth & adoption of financial applications can be traced back to the arrival of cloud storage in 2006. The big idea was the creation of a simple, scalable, service that could easily plug into existing software. The world of DeFi will mirror this trajectory, and usher in a wave of innovation the likes of which have never seen before in finance.

In the same way that cloud storage could replace central server racks and give a startup infinite scale capacity by plugging into an existing application, DeFi promises to do the same for financial operations. To be sure, financial services have experienced several developments in the last decade, but the idea of decentralized finance (DeFi) has made a huge impact on the future of the financial system and its current centralized structure. DeFi relies greatly on cryptography, blockchain, and smart contracts, with the latter being its main building block.

While DeFi is located in the blockchain and cryptocurrencies domain, the use of the technology is significantly larger in the financial world. According to CoinGecko, decentralized finance has over a $90 billion market cap as of this month. In simple terms, decentralized finance makes it possible for financial products to be open for anyone's use on a public decentralized blockchain network, eliminating the centralized structure that involves middlemen like brokerages or banks.

What’s more, DeFi also eliminates the requirement for identification numbers, making it possible for sellers, lenders, buyers, and borrowers to interact directly rather than seeking institutional help for transaction administration.

A Brief DeFi History

The term DeFi was first introduced in 2018 in a Telegram chat between entrepreneurs and Ethereum developers that include Blake Henderson of 0x, Inje Yeo of Set Protocol, and Brendan Forster of Dharma – who were thinking about the name of decentralized applications built on Ethereum.

Origin of DeFi

Source: Blake Henderson

The first DeFi application user was MakerDAO's stablecoin-based lending platform, which permits users to borrow a native token called Dai, which is pegged to the US dollar. This novel platform used smart contracts built on the Ethereum blockchain for loans, repayment and the liquidation processes. Since then, numerous platforms have started using DeFi to reward borrowers and lenders. The rising phenomenon of "liquidity mining and yield farming" where users shift crypto assets between different platforms and pools to earn interest and rewards is entirely built on Defi technology. The rise in the Ethereum price is also attributed to increased interest in DeFi.

The Most Popular DeFi Applications

The Ethereum network is certainly the most popular for building various blockchain based applications and is mostly used for DeFi due to its smart contracts and their ability to execute transactions when certain conditions are met.  Below are the most popular applications using DeFi technology. 

  • Decentralized exchanges (DEXs): These types of exchanges are gaining traction amid the exclusion of middlemen and brokers. DEXs uses DeFi technology and makes it possible for traders to connect directly for trading activities.
  • Stablecoins: The role of DeFi is significantly higher in stable coins, a cryptocurrency that is backed by an asset. The coin holders are eligible to commit assets to a liquidity pool while others can borrow from there by providing collateral. The interest rate will be adjusted automatically by the protocol according to the demand of the asset.
  • Lending platforms: The use of smart contracts by lending platforms to eliminate the role of banks raised the demand for DiFi technology.
  • Prediction markets: DeFi played a key role in ending the role of the middleman from betting on events and games.
  • Yield farming: The goal of maximizing the overall return by leveraging different DeFi protocols is known as Yield forming.

It Still Needs Infrastructure Improvement

The concept of decentralized finance is still new and needs a lot of infrastructural improvement to avoid hacks and mishaps. The lack of collaboration and inefficiency within the current financial system is among the cause of concern for the distributed nature of the decentralized finance ecosystem.

Conclusion

What makes DeFi similar to the cloud storage revolution of 2006 is the way it delivers two things we did not have in the world before: useful smart contracts and interoperability. DeFi is one of the biggest revolutions in financial technology systems since the invention of credit. While the use of DeFi has been increasing in various businesses and applications, the future prospects appear significantly bright as dApps are expected to make a big impact on our daily life and business activities.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Portfolio Insider

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