A blockchain-based new economic system powered by codes and run by decentralized applications is emerging as a more secure, transparent, and accessible alternative, changing the way we trade. We are now looking at a probable future where the global financial industry will be on one common peer-to-peer software infrastructure independent of the traditional centralized country-dependent institutions like brokerages, exchanges, or banks, which now serve as intermediaries. This is Decentralized finance or DeFi, the future of financial services or the financial services of the future, the market of which has already started to boom with Forbes reporting in January this year that DeFi now has a total value locked (TVL) of $100 billion USD on Ethereum alone. While according to DappRadar, there were over 655,000 daily unique active wallets across all chains in Q4 2021.
What is DeFi?
DeFi or Decentralised Finance is an emerging global financial system built on public blockchains, such as Bitcoin and Ethereum. Based on open-source technology it is an alternative to and completely independent of the traditional financial (TradFi) economy that aims at democratizing finance by removing centralized institutions such as banks, brokerages, and NBFCs (Non-Banking Financial Companies), and intermediaries through peer-to-peer (P2P) transactions and self-executing computer code called smart contracts that run on the blockchain network. Here individuals can act as exchanges, liquidity providers, and lenders instead. With intermediary or central authority involved, the financial services are rendered at a much lower cost and are hassle-free.
How does it work?
The smart contracts are developed to make the users perform some specific tasks under some pre-set conditions. No one can tamper with the smart contract once it is entered into the blockchain although everyone in the blockchain network can access and read it. These smart contracts can be accessed through decentralized apps, or DApps, which enable multiple parties to lend, borrow, trade, exchange on a safe and open network.
The Defi ecosystem
CEX examples: Binance, Coinbase, Kraken, Coinlist, etc
DEX examples: Uniswap, Pancakeswap, dYdX, Kyber, Sushiswap, etc
However, the system is not foolproof. Why?
- This is a new technology so unexpected hiccups may occur.
- There is no insurance by which to recover lost money.
- There is no authority to which you may lodge a complaint in case anything fraudulent happens to your DeFi transactions.