What Is Decentralized Finance?
While the applications of blockchain technology are explored in various sectors, one of the domains gaining maximum momentum is banking and finance. Decentralized Finance, commonly referred to as DeFi, is one of the most uprising trends of 2020 in the crypto and blockchain industry. While the DeFi ecosystem started drawing attention by the end of 2019, it has received a massive boost since the beginning of 2020. The value of tokens locked in DeFi stood at nearly $1 billion in February 2020. In a period of just 6 months, the value of tokens locked in DeFi has boosted to more than $6 billion. In this article, we are going to cover what is DeFi and what are the key aspects of the DeFi ecosystem.
What is DeFi?
DeFi refers to decentralized applications or dApps, built on the open-source blockchain networks (primarily Ethereum) that deal with finance. DeFi encompasses decentralization within the financial ecosystem. In a decentralized environment, individuals and institutions can access financial services in a transparent manner without any intermediaries. The traditional finance sector is largely centralized and incorporates a wide range of intermediary organizations. From lending to insurance services, the current financial infrastructure is inaccessible to a quite number of individuals — according to the World Bank, 1.7 billion people are unbanked across the globe. DeFi facilitates a decentralized financial system that is more accessible as well as technologically advanced, through the tools of smart contracts and dApps. In the centralized financial system, you never really control your funds. You never know what exactly your bank does with your money. Banks and governments have the power to freeze your funds at any moment, which is impossible in DeFi due to the implementation of blockchain technology. Decentralized finance allows individuals and organizations to take control of their funds and digital assets unlike in a centralized infrastructure. Decentralized applications on the blockchain can be integrated with each other, thereby enabling interoperability between different use cases of finance. For instance, a single user can access different applications for stablecoins as well as mortgage payments.
Key Components of a DeFi Project
The DeFi industry has gained significant prevalence in the last few months. The DeFi segment now incorporates multiple projects that cater to different financial products or services. However, the key characteristics of any DeFi project remain the same across the industry. Here are some components of a DeFi project.
Decentralized applications are built on open-source blockchain platforms. The source code used for building a DeFi product is open and accessible to all. This ensures transparency in the product as well as community integration. This is how the security of the product or service is guaranteed.
The DeFi applications are completely decentralized and not managed by a single authority. Instead, operations of a DeFi product are managed through smart contracts, algorithms written in the form of codes and deployed on dApps. Interactions between participants run on a peer-to-peer network without any intermediary in-between.
DeFi protocols facilitate greater accessibility to the financial product without any restrictions to geographical location, space, and time. To access a service in the DeFi industry, the minimal requirement is a smartphone and internet connection. Moreover, the service is not restricted to geographical boundaries thereby ensuring accessibility to the unbanked population, remote villages, and economically weaker regions.
The DeFi products are built on decentralized blockchain platforms, primarily Ethereum. This enables DeFi crypto transactions and activities available to the users on a transparent public ledger. Moreover, decentralized environment and transparency ensure accountability in activities unlike traditional finance, in which all the activities are controlled, operated and managed under a central body.
The decentralized applications are permissionless and any individual or organization can build a dApp on a blockchain network. This allows anyone to build a DeFi app and innovate it to the maximum extent. Unlike traditional finance which needs to pass through a set of regulatory approvals, decentralized finance apps do not need approvals, and users can directly link their crypto wallets.
DeFi technologies allow interoperability between multiple products of the financial ecosystem. It enables secure exchange of required data from one DeFi product to another. For instance, a user can integrate stablecoins, wallets, and lending applications even though they are separate products of the decentralized finance industry.
Key DeFi Projects in 2020
DeFi innovates the existing financial system bringing new value and use cases to finance and banking. The use cases and products of DeFi include stablecoins, lending, trading, investments, insurance, etc. DeFi projects catering to these use cases have drawn much attention from investors and traders. One of the most recognized DeFi projects so far is MakerDAO. MakerDAO is a decentralized autonomous organization that incorporates a stablecoin, Dai, to allow lending and borrowing of cryptocurrencies without any intermediaries. The project leverages smart contracts to manage the borrowing and lending of crypto without any centralized entity. The services are managed through two cryptocurrencies: Dai, a stablecoin fixed at $1 and MKR, the native token of the MakerDAO project. Chainlink is another DeFi project whose value has increased exponentially since the beginning of 2020. The project links the information to and from blockchain-enabled smart contracts to the ‘real world’. It incorporates ‘oracles’ that deposit data from the outside world to smart contracts. In turn, smart contracts automatically execute pre-defined conditions. DeFi projects need oracles to further act as defined. The Chainlink project facilitates DeFi protocols with oracle services. The decentralized nature in borrowing and lending services, as well as supporting infrastructure for DeFi to perform at its optimum capacity, have given an edge to MakerDAO and Chainlink. On ChangeNOW, you can buy these and many other DeFi tokens registration-free in a matter of a few minutes.
Decentralized finance in 2020 is yet to overcome the decentralized ICO volume of 2017 and 2018, but the market cap of DeFi cryptocurrencies has skyrocketed as much as 600% in the last six months. DeFi cryptocurrencies continued an upward momentum throughout the year even amidst the coronavirus crisis. DeFi protocols and subsequently their cryptocurrencies are finding innovative applications catering to different financial products and services. Most of the decentralized applications of this domain are built on the Ethereum blockchain network. The functionality of dApps also allows different applications to be integrated with each other.
While the industry still has tough waters to navigate and challenges to overcome, let it suffice to say that the entire industry has kicked off quite rapidly. The year 2020 has seen exponential growth within the DeFi industry which continues to boom with each passing day. Moreover, the industry not only promises to transform the existing infrastructure of traditional finance, but technological innovations like digital assets can also be deployed using DeFi protocols. Overall, the current scenario, analysis, and studies predict that this is just the beginning. DeFi is here to stay!