The Financial Revolution of Defi : A Catalyst for Change
The rise of DeFi seems like a revolution in the financial landscape, offering a decentralised alternative to traditional finance. With its emphasis on financial inclusion, innovation, and financial sovereignty, DeFi has attracted millions of users worldwide, fostering a rapidly growing ecosystem of decentralised applications and protocols.
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In recent years, decentralised finance, or Defi, seems to have revolutionized the financial landscape, which has felt remarkable transformation. It provides open, permissionless, and decentralised alternatives to various financial services that disrupt traditional financial systems.
What is Defi?
Decentralized finance (DeFi) is an emerging model for organizing and enabling cryptocurrency-based transactions, exchanges, and financial services. DeFi’s core premise is that there is no centralized authority to dictate or control operations.
Evolution and current state of DeFi markets
Decentralised projects came to the forefront in the past 5 years but gained traction in the summer of 2020, when the market grew to over USD 50 billion in assets locked in DeFi protocol smart contracts. Defi leverages blockchain technology to offer an array of financial services and products without the need for intermediaries or centralized authorities. This newfound financial freedom and accessibility have sparked a wave of DeFi innovations, reshaping the finance landscape.
Market evolution and trends
The rapid growth of the DeFi market attention from market participants and policy bodies in the summer of 2020 (referred to as ‘the DeFi summer’), when a number of DeFi applications appeared to gain traction with users, has since grown to a multiple of its initial size. The gross total value of crypto-assets locked in ETH-based DeFi applications (TVL) as of November 2021 reached USD 100 billion, up from USD 1.9 billion on July 2, 2020 (a 50-fold increase, albeit from a very low base). Alternative blockchains, such as Binance Smart Chain and Polygon, are increasingly growing their presence in the DeFi space (19% and 9% of TVL, respectively, as of June 16, 2021).
Governance tokens
In concept, governance tokens are a critical part of the DeFi ecosystem, as governance of DeFi protocols is to a large extent based on voting by tokenholders for any decision associated with the application. In practice, however, there are a lot of limitations to this. In concept, any member of the community can raise on-chain proposals to the community, and governance tokenholders are called to vote on proposals or other important decisions that need to be made. Proposals can include upgrades, changes in the mechanisms underlying the protocol, and the introduction of additional stablecoins for trading.
The role of stablecoins
The role of stablecoins in DeFi markets is critical, as DLT-based fiat-backed tokens are some of the main types of collateral used to provide liquidity to DeFi applications. Total stablecoin supply stood at USD 73.5 billion as of June 30, 2021, with Tether, USD Circle, and Binance USD dominating issuance. These three stablecoins are backed by fiat collateral, while DAI, MakerDao’s stablecoin, is a cryptocollateralised stablecoin. Crypto-collateralised stablecoins, such as DAI, are backed by cryptoassets and are therefore less linked to the traditional financial system, although DAI still aims to maintain a (soft) peg to the USD, trading at or around 1 USD on average. In terms of market capitalisation of stablecoins, the above-mentioned collateralised stablecoins comprise 87% and DAI 5% of the market.
Impact on Traditional Finance
The rise of DeFi innovations is causing ripples in the traditional finance industry.
Regulatory challenges
The decentralized and borderless nature of DeFi presents regulatory challenges for governments and financial authorities worldwide, as traditional frameworks may only partially apply.
Disintermediation
DeFi eliminates the need for intermediaries like banks and financial institutions, potentially reducing transaction costs and providing greater financial autonomy to users.
Global reach
DeFi operates on the internet, enabling users from anywhere worldwide to participate, invest, and access financial products without geographical restrictions.
Financial inclusion
DeFi opens access to financial services for the unbanked and underbanked populations worldwide, bridging the gap between traditional finance and those excluded from the system.
Speed and efficiency
Transactions on DeFi platforms are typically faster and more efficient than traditional financial systems, which may involve manual processes and settlement delays.
Regulatory challenges
The decentralized and borderless nature of DeFi presents regulatory challenges for governments and financial authorities worldwide, as traditional frameworks may only partially apply.
The rise of DeFi has been nothing short of a financial revolution, offering a decentralised alternative to traditional finance. With its emphasis on financial inclusion, innovation, and financial sovereignty, DeFi has attracted millions of users worldwide, fostering a rapidly growing ecosystem of decentralised applications and protocols. While the challenges of security and regulation persist, the potential impact of DeFi on the financial landscape cannot be ignored. As the DeFi space continues to mature, it has the potential to reshape the global financial system, providing a more open, accessible, and equitable future for finance.