Decentralized Finance (DeFi) creates almost endless opportunities for anyone with a smartphone and Internet access – according to experts. The DeFi sector is now worth billions. But will decentralized finance remain the big thing in the future?
“How DeFi is revolutionizing the financial world”. “DeFi drives crypto growth in North America”. Headlines like those from Money control and Coin Rivet last year make it clear: To say that 2021 was a successful year for decentralized finance (DeFi) is a major understatement. According to Daily coin, the total value of completed DeFi applications (Total Value Locked) exceeded $240 billion at the end of December. TVL is the most common metric to measure the volume of the decentralized financial industry. And the signs seem to be pointing to “boom” for 2022 as well. Or as Sameep Singhania, co-founder of decentralized exchange Quick Swap, writes on digi-platform “HodlX,” “The rapid growth we’ve seen in 2021 is just the beginning.” But there are also voices warning of problems in the brave new DeFi world and calling for regulations and adjustments.
What’s clear is that anyone who wants to harness the potential of DeFi should know the rules of the game – and not only have important key terms down, but also be aware of the risks and challenges in the world of decentralized financial services. Here are answers to important questions about DeFi.
DeFi – what is it anyway?
As is so often the case in the digital universe, the term DeFi comes from English: It stands for Decentralized Finance. In Europe, the whole thing is also called decentralized financing, decentralized finance, or decentralized finance. DeFi is the digitalization of services in the financial sector. The blockchain-based form of finance stands for digital peer-to-peer services that offer crypto trading, loans, interest accounts and other services.
What are the benefits of DeFi?
DeFi is “rebuilding our financial sector from the ground up,” writes BTC-ECHO. It allows market participants: inside to trade directly with each other and speculate on price movements across a wide range of assets. It also enables people to borrow or lend money from others without intermediaries (e.g., banks) via DeFi lending platforms. “Our legacy financial infrastructure has both limited growth opportunities and contributed to inequality of opportunity. Globally, 1.7 billion people are unbanked” criticizes Professor Campbell R. Harvey of Duke University in the US.
Why are many experts excited about DeFi?
DeFi promises a fairer, more democratic financial system. Finance scholar Harvey, co-author of the study DeFi and the Future of Finance, describes DeFi as a peer-to-peer system that is not controlled by a centralized institution such as a bank, stating, “Eliminating centralized institutions greatly reduces costs, makes credit more affordable, and increases deposit rates. Transactions are instantaneous and secure. In addition, everyone is treated equally, essentially democratizing finance and reducing the inequality of opportunity that plagues current systems.”
So how does it all work?
DeFi is based on decentralized blockchain technology, which in turn supports “smart contracts.” Smart contracts are computer protocols that can facilitate, verify, or negotiate a contractual agreement. Smart contracts are the foundation for most DeFi applications and platforms. In the use case, DeFi stands for decentralized applications, also known as dApps, where user: ins are given their own crypto wallet with which they can buy, sell or trade crypto assets.
Where does DeFi originate?
For DeFi, too, it all started with Satoshi Nakamoto and the cryptocurrency Bitcoin in 2008. Bitcoin was the very first crypto-defi project, so to speak. In the meantime, the term has spread throughout the entire digital financial world. DeFi services are increasingly being used on the Ethereum blockchain. The reason for this: “Unlike Bitcoin, Ethereum is programmable and offers a marketplace for many applications,” explains financial expert Roberto Zimmerman on morethandigital.info, a platform for business knowledge.
What are the applications?
On the one hand, there is traditional lending. Thanks to the blockchain, the whole process should be faster and easier. The technology (instead of a human) checks the solvency and collateral of the contractual partners. The next use case, borrowing, is similar. The blockchain is also the home of decentralized exchanges (DEXs), which are considered the basis of the DeFi economy. There are also now numerous applications and apps for trading itself in the DeFi space. And then there is Yield Farming. This is a way to earn a fixed interest rate via DeFi – for example, by investing cryptocurrencies or providing them for loans. Closely related to this is liquidity mining. This means that for certain DeFi coins, miners are rewarded who provide the network with the necessary liquidity.
What are the risks and problems?
On the technological side, there are cybersecurity threats and hacks that the entire crypto world is suffering from. For example, a study by market research firm Elliptic predicted a loss of $10.5 billion from DeFi fraud and theft in 2021. The interoperability of the DeFi ecosystem (keyword sidechains, parachains, bridges) is both an advantage and a risk. The technical standards are still evolving, and each protocol has a different software code base. There is also the risk of investment loss, which exists with DeFi just as it does with conventional markets: cryptocurrencies are known to be a volatile asset class.
Is DeFi hype or come to stay?
While the DeFi industry is expanding at breakneck speed and shaking up traditional legacy and central institutions, typically banks, the crucial question from an Expert: inside perspective remains “whether the DeFi movement will be accepted by the masses,” says, for example, Cryptoscene Editor-in-Chief Raphael Adrian. At the same time, he warns, “Crypto is and remains a highly speculative investment field.”
What will 2022 bring?
With consumer interest skyrocketing, DeFi industry innovators have begun to make their solutions more accessible and usable for “ordinary” consumers. One example among several is the partnership announced in November 2021 by Alchemy Pay and Bella Protocol, which are collaborating on the launch of CeFi (aka Centralized Finance) and DeFi return products to “drive mass adoption of DeFi wealth management,” according to a press release.
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