If you follow crypto, chances are you've been hearing a lot more about something called 'DeFi,' or Decentralized Finance. It may be the hot buzzword of the industry today, but it's been one of the fastest growing sectors of the blockchain industry since 2019, with far reaching implications for the future of the finance.
Those implications stem from one key difference: in traditional financial services, 3rd party middlemen are required for for every transaction, while the DeFi movement is trying to eliminate that need. Like crypto overall, the DeFi ecosystem offers an alternatived to most available financial service: savings, lending, trading, insurance, and more.
In this article, we will explore the development of the DeFi ecosystem and explain 2 essential points:
- DeFi vs CeFi, what's the difference?
- DeFi use cases
What is DeFi?
DeFi is simply an abbreviation of the phrase "Decentralized Finance." Traditional finance relies on third parties such as banks or courts to act as intermediaries or to provide arbitration. DeFi theoretically allows anyone with Internet access to be able to trade, lend, borrow and bank without the need for middlemen. No need for identification documents either, as long as you have access to the ecosystem.
DeFi offers several advantages versus traditional centralized finance, linked primarily to the inherent nature of blockchain:
Programmability: Many DeFi projects rely on highly programmable Smart Contracts to automate execution and enable the creation of new financial instruments and digital assets. This reduces the effective costs of the services.
Immutability: Tamper-proof data coordination across a blockchain’s decentralized architecture increases security and auditability.
Permisionless: DeFi enables people who don’t have access to financial services to take part in the global economy. While traditional financial services require administrative paper work, DeFi only requires an internet connection.
DeFi Use Cases
Having only gained traction in the last year, the young DeFi space already covers plenty of traditional financial services.
Crypto Lending & Borrowing
This may be the most popular use case of the ecosystem today. DeFi lending and borrowing platforms allow anyone to borrow and lend as long as they have the appropriate crypto assets to loan out or use as collateral. The most popular method of lending/borrowing in DeFi is the use of lending pools such as Compound or MakerDAO.
Lenders earn interest on the assets deposited in the pool. Borrowers can then take loans from this pool of assets. Borrowers interests on the loan are split up between all of the lenders, based upon the amount they deposited in the pool.
Decentralized monetary banking services
This area of the DeFi ecosystem covers the issuance of stablecoins, mortgages or insurance. One of the biggest factors limiting the global adoption of cryptocurrencies is price fluctuations, making many impractical for everyday use.
Enter the staggaring rise of stablecoins, crypto assets programmed to have a consistent value, usually pegged to traditional currencies such as USD or EURO. but unlike fiat, they have the advantage of being digitally transferable around the world with ease, and at lower costs.
A Decentralized Exchange, or DEX, emulates centralized exchange services. But instead of the exchange 'holding' your assets and executing your trades, a DEX allows users to manage their funds themselves through a series of smart contracts.
In fact, DEX options are on of the more common user requests here at Quadency so rest assured DEX trading is on the roadmap!
What's next for DeFi?
This first generation of 'dapps' relies heavily on collateral: to borrow some crypto, you need to already own some. As such, we could see further growth of tokenizing real-world physical assets' for use as collateral.
Source: The Block
These applications may be the most popular today, but as you can see above there's much more to DeFi than borrowing and lending. And as we head towards a more decentralized world, the demand for DeFi will follow.
DeFi is already starting to provide improved alternatives to traditional finance, with new use cases being established every day.
But if 2019 is remembered as the year DeFi's growth began, 2020's focus would be the rise of DeFi Tokens.
Stay tuned for our next post in this series, an Intro to Defi Tokens with key insights for traders.
Disclaimer: contents of this article are for general market education and commentary and are not intended to serve as financial, investment, or any other type of advice.
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