Is DeFi the Financial Revolution that Bitcoin Promised?
The “DeFi financial revolution”, as many are calling it, is a promising solution to the global unbanked crisis, even if not anything else. As per recent World Bank data (2018), 1.7 billion adults around the globe don't have bank accounts. Under the existing, intermediary-driven fiat systems, this means they have little or no access to financial services.
Simultaneously, however, around 57% of the world’s population today has internet access, while 67% has a mobile device of some kind. Emerging FinTech solutions, especially the Decentralized Finance or DeFi movement, is a vision to bring financial services to this massive unbanked population.
As people are becoming more and more aware of the possibilities that DeFi brings to the table, there has been a steadily rising interest in its domain, both individual and institutional. According to Victoria Oslina, between 2018 and 2019, there was a 273% surge in Google searches for the phrase “decentralized finance”.
That apart, there have been consistent innovations and investments in the industry: at the time of writing, the total market cap being $3.2 billion. That said, let’s discuss some of the essential aspects of DeFi for a better understanding of the DeFi financial revolution. As many people believe, and with reasons, decentralized finance is the future of our financial systems, so you might as well be highly interested.
The Rise of the DeFi Financial Revolution and Open Financial Systems
As such, the DeFi movement aims to establish an open financial system, as opposed to the existing, centralized ones. Broadly, it’s a situation where financial activities are performed on a peer-to-peer basis, without the need for banks or other intermediaries.
To understand it’s relevance and how it emerged, we only need to consider the major issues with centralized finance. Intermediaries such as banks, payment gateways, lending firms, and so on, not only facilitate but also control the system. Among other issues, the centralized storage of financial data heightens the risk of theft, while also facilitating corruption.
Moreover, fiat currency is susceptible to inflations which result in depreciation in the value of personal savings. For evidence, remind yourself of the numerous scams and frauds in the history of fiat systems, including the devastating 2008 market crash.
Partially driven by these factors, the DeFi financial revolution is all about innovating practical, blockchain-based decentralized solutions to replace the centralized finance systems. Indeed, on the outside, it appears to be the same promise that Bitcoin made in 2008. People have often indulged in heated DeFi vs Bitcoin debates to tackle this, but in reality, the notion is ill-informed.
While Bitcoin is about decentralized storage and transfer of value, DeFi comprises a complete, yet decentralized financial system: savings, tradings, loans, insurance, everything. In fact, as contributors to the evolution of DeFi, Ethereum, Bitcoin, and some other blockchain platforms have been the most crucial.
In many ways, Bitcoin was the spark: the beginning of a chain reaction underpinning the rise of decentralized finance. Bitcoin, followed by other cryptocurrencies, made money and payments accessible to anybody who had an internet-enabled device. Now, DeFi brings the entire financial system to these people: the reason why we are calling it the DeFi financial revolution.
The Working of Decentralized Finance
There are some obvious questions: how does DeFi actually work? More importantly, how is it different from the traditional systems? Let’s see.
Presently, the Ethereum blockchain supports most of the DeFi applications, because of its programmable “smart contracts”. In short, a smart contract is a code block that automates processes based on certain predefined conditions and is used to develop Decentralized Applications or dApps.
At its core, the DeFi ecosystem comprises of open-source, financial dApps which allow users to create Stablecoins, earn interests by lending money in cryptocurrencies, borrowing, exchange assets and create new ones, and so on. However, despite similar scope, DeFi apps are characteristically different from traditional banks or other financial institutions.
Automated Compliance: Mathematical algorithms ensure compliance with the rules, eliminating the need for human supervision. Although developers still have to maintain and update these apps, the financial processes can function without any central governance.
Transparency: As the code is hosted on public blockchains which every network member can audit at will, DeFi apps are highly transparent. This is the exact opposite of traditional finance works.
Global Access: Not only are DeFi accessible irrespective of geographic location, but they are also “permissionless”. Thus, anyone can create and/or join an open-source DeFi app, thus avoiding the gatekeepers and tedious formalities of centralized finance.
These, however, are only three of the most prominent differences. There are more, with many more to come with further innovations.
Risks Involved with DeFi Apps
As with any other application, there’s always the possibility of coding errors in DeFi apps. In turn, these might becomes openings through which hackers can attack the finances of the users. For instance, in 2016, 3.6 million ETH, worth nearly $60 million, was stolen in the now-infamous DAO attack.
Furthermore, on Black Thursday 2020 — the stock market crash of March — challenged the stability of Stablecoins, which are ideally meant to be non-volatile. Investors of MakerDAO (presently the most famous DeFi platform) lost $8.325 million, consequently filing a lawsuit against the company. According to the suit, the company “intentionally misrepresented the risks associated with CDP ownership.”
Nonetheless, the fact remains that even though such incidents raise serious questions, they do not challenge the potentials of the original principles. For one, there has always been prompt action against such unfortunate events, ruling out any future possibility. Moreover, it’s crucial to remember that these systems are still in their nascent stages, undergoing constant upgradation and reinforcements.
Decentralized Finance is the Future
Coming back to our original question: is the DeFi financial revolution a fulfilment of what Bitcoin promised? Indeed, but with a wider scope than the founders of Bitcoin might have imagined. If Bitcoin was the sapling, DeFi is the tree. Through a decade of promising innovations, we have arrived at a point where we have the resources to holistically transform the Fintech future with DeFi. Of course, there are shortcomings, but there’s nothing that’s indomitable.
Already, projects are underway for evolved versions of Ethereum and Bitcoin. Further, driven by rising interest, research and development of DeFi applications is also on a high. Lastly, funds locked with Maker, Compound, and Synthetix, among others — the major players of the DeFi financial revolution — is constantly rising. In all, we can truly claim that decentralized finance is the future, a financial revolution.