For the blockchain sector, 2020 was clearly the year of Decentralized Finance; while the rest of the world was gripped by fears of COVID, blockchain caught the bug of decentralized finance with crypto enthusiasts, and now decentralization is the current trend in the global financial market.
Undoubtedly, blockchain technology can reduce transaction costs, generate distributed trust, and empower decentralized platforms, potentially becoming a new foundation for decentralized business models. So whether you are a skeptic or a fanatic about DeFi, the fact remains that it is the current rage.
2020 - A LANDMARK YEAR
To simplify it, decentralized finance refers to an ecosystem of financial products that do not rely on traditional financial intermediaries such as banks and exchanges. Central to the success of decentralized finance are smart contracts, which are deployed on Ethereum – contracts that two parties can deploy without an intermediary. DeFi also gives rise to decentralized apps, giving developers the ability to build applications on top of the Ethereum blockchain.
It is as much of a philosophy as a way of business, and it advocates a transparent financial ecosystem that is open source, available to everyone and operates without a central authority. 2020 was dominated by the DeFi conversation as the total volume locked (tvl) in the sector first surpassed $1 billion in the year. Moreover, the figure which represents the dollar value of assets locked in DeFi protocols closed out the year at about $13 billion, demonstrating 2,000% growth since January.
For the outer world, payments that take place on open decentralized blockchains should look and feel the same way as regular transactions of today using debit cards and smartphones. Users wouldn’t even know their transactions are taking place on a blockchain. 2020 has shown incredible interest in cryptocurrencies and decentralized technologies, both among private companies and governments and in many countries. It is logical to assume that next year this trend will not only continue, but intensify.
POTENTIAL APPLICATIONS OF DEFI
Smart contracts eliminate the need for an intermediary and thereby the need to exchange exorbitant fees to facilitate financial transactions. DeFi provides these same services, not only faster and cheaper, but also in a way that is more secure. They also give developers increased functionality instead of merely building programs that send or receive cryptocurrencies. Smart contracts can be used to create programs on the blockchain that execute when certain conditions are met.
Monetary banking services are another potential use, but one that is maturing through the creation of stable coins. These coins are types of crypto assets, usually pegged to a real-world asset, such as fiat money or exchange-traded commodities. These stable coins help mitigate the mortality in cryptocurrencies, allowing them to be used as a form of cash without the need for a central authority. Stable coins might be beneficial in the processes that require many intermediaries, such as mortgage or insurance applications. It also has certain advantages over the traditional credit system of borrowing and lending.
Furthermore, given its ability to collateralize digital assets and provide immediate settlement, it negates the need for credit checks, and through standardization can make the process more efficient. It reduces the risk of default for lenders and can offer cheap and fast services to a broader audience of borrowers.
PROMISES AND CHALLENGES
Powered by blockchain technology, decentralized financial services have the potential to broaden financial inclusion and facilitate open access. It encourages permissionless innovation and creates new opportunities for entrepreneurs and innovators, making the financial system more distributed, innovative, interoperable, transparent, and borderless.
Having said that, it’s crucial to take regulation into account. While decentralization has numerous advantages, without regulation to provide assurances to investors and consumers, it will not be easy to attract investors into trusting new financial services and security classes. Scalability, as well, has often been the bane of blockchain and decentralized finance. Regulation and compliance build trust, and this may be what decentralized finance needs to gain traction in the financial community.
One of the areas that experts see great potential for DeFi is how businesses manage their money better. It has been noted that while unspent capital is based on the low-interest accounts in the traditional banking sector, staking rewards, lending protocols, and liquidity mining offer the opportunity for small businesses to manage their cash flow better. There are obvious ways that it can improve the business banking experience, DeFi should not only prove to be faster and cheaper than traditional banking, but at the same time it can open up new possibilities for improved treasury management.
While eliminating intermediaries and conducting financial transactions through a smart contract on a distributed ledger is ideal, in real life, however, things break and stuff like hackers breaking into smart contracts are significant concerns. A case in point is how thieves gradually stole 450 million dollars of Bitcoin from Mt. Gox exchange from 2011 to 2014. The community, it is said, is doing its best to address such issues through community governance.
NOT JUST A FRINGE IDEA
Thanks to a number of growing projects in decentralized finance (once a fad), it is actually gaining relevance today as ideas and technologies begin to be applied by several giants in the financial market. A large public company, xSigma, has already announced the launch of its first decentralized finance products.
The team plans to launch a decentralized exchange for trading stable coins, culminating in 2022 with the launch of a $1 stable coin. Moreover, it is already used by Amazon, BNP Paribas, Citigroup, Facebook, Google, JP Morgan Chase, IBM, and hundreds of other large public networks.
Large companies have appreciated the advantages of decentralized finance technologies, not only in terms of investment but also as instruments with massive potential for development. Despite some skepticism, most businesses see huge potential in this industry and will try to implement it. As the price of bitcoin surges past $23,000, there are plenty of reasons for decentralized finance and crypto enthusiasts everywhere to look ahead with a sense of excitement and optimism.
The future is looking DeFi-nitely exciting!