What in the world is De-Fi? And how does it fit into blockchain? Today, we’re taking you through the whole concept of Decentralised Finance.
De-Fi refers to the shift from a traditional, centralised financial system to a decentralised one created and enabled by blockchain technology – more specifically, the Ethereum blockchain.
What is Ethereum again? Take a quick refresher with a previous article from us and get some pointers. All you have to know for now is that Ethereum is an open-sourced, decentralised software platform that enables smart contracts and distributed applications (DApps) to be built and run on it.
Think of it like an app store, an ecosystem that allows layers of apps to be built on it. Simple, but makes sense right?
Ethereum is also a programming language, and is currently used to build software and programs that enable financial institutions and individual investors alike to transact in a more decentralised and open manner.
If all you know about digital finance up until this point is e-payments as well as cryptocurrency like ‘bitcoin’, then this is a good place for you to learn about the latest fintech trend – De-Fi.
What is ‘De-Fi’ and ‘money legos’?
A decentralized financial system refers to a peer-to-peer system enabled by decentralized technologies built on the Ethereum blockchain. It is an ecosystem without any central authority: open-source, transparent and permissionless. Here, users have total control over their assets and can interact with others through decentralised applications (dApps).
Decentralised applications are applications that are run on many computers instead of 1 main server or computer.
DeFi protocols are composable, meaning different components of a system can easily connect and inter-operate using the same components. Composable code has created a powerful network effect in which the community continues to build upon what others have built.
Many liken the process of DeFi development to building with legos—hence the nickname ‘money legos’.
How De-Fi is changing the traditional finance industry
With over $9 billion worth of value locked in Ethereum smart contracts in 2020, decentralized finance has emerged as the most active sector within the blockchain space. There are a wide range of use cases for individuals, developers, and institutions; from lending and borrowing platforms to margin trading, the DeFi ecosystem has launched an expansive network of integrated protocols and financial instruments.
But DeFi developers and entrepreneurs aren’t just building parallel financial systems, they’re unlocking completely new instruments, from flash loans to automated money markets. They are creating a wholly new financial experience for end users.
Imagine for a moment what it would be like if everyone in the world had access to the internet and could access these services.
The traditional role banks, financial institutions and centralised markets would almost certainly be significantly altered.
This is probably why even Siam Commercial Bank (SCB) has dipped their toes into this new technology by investing in BlockFi earlier this year.
So what are the services offered by De-Fi applications?
Some DeFi innovations, services and use cases:
There are so many use cases and DeFi innovations that it would take a book to list them all. But here are some of the more practical, everyday and relatable ones.
-
Lending and borrowing
Peer-to-peer lending and borrowing protocols are some of the most widely used applications in the DeFi ecosystem. Interest rate protocols like Compound, for example, provide interest rate markets on Ethereum, allowing users to earn interest on crypto assets they’ve supplied to the lending pool.
The Compound smart contract automatically matches borrowers and lenders and calculates interest rates based on the ratio of borrowed to supplied assets. As more products integrate the Compound protocol, more and more crypto assets will be able to earn interest, even when idle.
-
Savings
By plugging into lending pool protocols like Compound, many DeFi applications offer interest-bearing accounts that can earn exponentially more than traditional savings accounts.
One DeFi activity that has exploded around these innovative savings mechanisms is “yield farming.” Yield farming refers to users moving their idle crypto assets around in different liquidity protocols to maximize returns.
In Thailand, the digital exchange platform Zipmex recently launched a savings product that allows users to earn up to 10% on their digital assets.
While this account does not require users to move their assets to around different liquidity protocols, it does show that the use cases for DeFi are increasing investment opportunities for retail investors, pushing blockchain technology towards the mainstream and becoming an attractive option for modern investors who prefer not to dump money in the bank and endure sub-inflation interest rates.
-
Payments
Peer-to-peer payment is the foundational use case of the DeFi space and of the blockchain ecosystem at large. Blockchain technology is designed so that users can transact cryptocurrency securely and directly with one another without middlemen.
DeFi payment solutions are creating a more open economic system for underbanked and unbanked populations and also helping large financial institutions streamline market infrastructure and better serve wholesale and retail customers.
-
Tokenization
One of the cornerstones of decentralized finance and a native functionality of the Ethereum blockchain, tokenization fuels the network but also unlocks a variety of economic possibilities.
Simply speaking, a token is a digital asset that is created, issued, and managed on a blockchain. Tokens are designed to be secure and instantly transferable, and they can be programmed with a range of built-in functionalities.
From real estate security tokens that represent fractionalized properties to platform-specific tokens that incentivize the use of a particular application, Ethereum-based tokens have emerged as a secure and digital alternative for users across the world to access, trade, and store value.
In Southeast Asia, investors will soon be able to trade the C8P token, created to optimize the ease of investment from centralized exchanges to decentralized exchanges like UNISWAP.
This project is actually the brainchild of the StockRadars team in Thailand, which is trying to leverage their stock-trading user base to switch over to digital assets and at the same time, expand abroad through Zipmex Indonesia.
Key Takeaways
While the total value locked in the DeFi space is only a fraction of the volume in traditional markets ($9+ billion vs $30+ trillion in the U.S. stock market), what’s happening in DeFi is an important signal for the traditional financial industry, even in Thailand. Many are expecting the types of use cases within finance to grow exponentially.
As DeFi makes blockchain technology more mainstream, more and more users will demand the level of financial access, opportunity, and transparency that decentralized protocols provide.
Large institutions now have the privacy and security guarantees they need to adopt decentralized technology and meet regulatory standards.
As institutions and retail investors begin to adopt some of these new technologies, regulators will have to take note and continue to adapt their policies to encourage innovation and foster economic growth.
With such limitless opportunities and innovations in finance, surely the financial market infrastructure of the future will largely be decentralized?