DeFi is the abbreviation of "decentralized finance", which is a general term for various financial applications in cryptocurrency or blockchain, aiming to transform financial intermediaries.
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🔎What is DeFi?
Decentralised Finance means "decentralized finance" in Chinese, often abbreviated as "DeFi", which is a term describing a blockchain-based financial service system that allows transactions without the approval of government agencies.
In simple terms, DeFi is like a blockchain financial institution or banking system where you can trade digital assets or cryptocurrencies without having to incur transaction costs incurred by institutions such as central banks.
DeFi is also a free, open-source digital marketplace that enables users to innovate and develop their own decentralized applications (dApps) by writing code.
These platforms provide payment services, trading and investment, lending, insurance and asset management, etc. Although DeFi seems to be very attractive and beneficial to users, it also comes with associated risks.
🔎DeFi Where does it come from?
DeFi (decentralized finance) originated in 2017. It is a financial service system based on blockchain technology and cryptocurrency. It aims to achieve fair, transparent and trustless transactions in the financial market through a decentralized approach.
The rise of DeFi is closely related to the development of the Ethereum blockchain. In 2017, MakerDAO, a decentralized lending platform on Ethereum, was born. It realized decentralized lending through smart contracts, which was also the prototype of DeFi. Since then, DeFi has gradually attracted attention and attracted more and more developers, investors and users to participate.
Today, DeFi has developed into a huge ecosystem covering multiple fields such as lending, trading, insurance, savings, etc. According to DeBank data, as of August 2021, the total locked value (TVL) of DeFi has exceeded US$1 trillion.
As DeFi continues to develop, it is gradually changing the landscape of the traditional financial market and providing more financial service options for global users.
🔎What are the characteristics and advantages of DeFi?
The two core characteristics of DeFi - permissionlessness and transparency - provide opportunities for multiple powerful application scenarios.
🚩Lower entry barriers, reduce switching costs, and provide optionality
The permissionless nature of Ethereum applications makes it easy for anyone to copy and adapt their code bases, which greatly reduces the barrier to entry for entrepreneurs.
At the same time, since all applications share the same Ethereum blockchain database, users can easily transfer funds between different platforms, which greatly reduces conversion costs.
This environment encourages projects to compete on fees and user experience to attract more users. In short, Ethereum applications lower the entry barrier, reduce switching costs, and provide users with more choices.
🚩Coordinate incentive mechanisms to solve agency problems
DeFi protocols are secured at the protocol level by implementing reliable, self-executing smart contracts (commonly referred to as “smart contracts”).
In other words, by using these trustless, programmable escrow accounts, we can ensure that incentives are aligned so that the principal-agent problem is effectively solved.
🚩Transparent accounting and rigorous risk assessment
Transparency of capital reserves in DeFi ensures rigorous risk assessment and risk management.
For decentralized money markets and credit facilities (which allow users to obtain peer-to-peer, secured loans), users can view the quality of the collateral portfolio and the level of leverage in the system at any given moment.
🚩Global access, unified market
International markets are inherently more liquid and can significantly reduce transaction costs for all market participants.
🚩Modernized infrastructure, improved market efficiency and robustness
In the Internet age, our ideal capital flow should be as seamless as the flow of information. In particular, the settlement process should be completed instantly, transaction costs should be minimized, and services should be uninterrupted 24 hours a day, 7 days a week, and 365 days a year.
However, our global financial system currently operates only during the 9-to-5 working hours (excluding weekends and holidays), which is obviously inefficient. In other words, we need to modernize the infrastructure to improve market efficiency and robustness.
🚩Scalability
Ethereum, the infrastructure of DeFi, needs to scale to cope with the growing bandwidth demand. Currently, Ethereum processes about 1.5 million independent transactions per day, which is close to its maximum capacity, causing transaction fees to soar.
However, scaling cannot sacrifice the principles of security and decentralization. Over the years, after intensive research and development, a variety of scalability solutions have emerged that promise to reduce the burden on Ethereum while maintaining its core features.
The development of DeFi will continue to drive the development of decentralized software and applications (Dapp), further enhancing the decentralized financial ecosystem.
🚩Real-time data
One benefit of building financial services on a transparent shared database, the distributed ledger of a blockchain, is that all relevant transaction data is publicly available in real time.
For example, in the Uniswap protocol, the returns generated by liquidity providers (LPs) can be tracked at a granularity of one second. Investors can use this data to decide how to allocate funds, provide more efficient price discovery and resource allocation, and regulators can also monitor real-time transaction data to identify illegal user activities.
🚩Eliminate counterparty / credit risk and reduce compliance costs
DeFi platforms are “self-custodial,” meaning users never give their assets to a centralized operator.
While DeFi may seem daunting to some at first, its self-custodial nature helps eliminate counterparty and credit risk, which in traditional finance is often associated with one party defaulting or failing to meet its obligations in a transaction or loan.
Analysts estimate that the total value of cryptocurrencies lost through centralized exchanges (CEXs) exceeds $7 billion since 2011. These losses can be due to hacker attacks or operators deliberately absconding with user funds.
DeFi represents a paradigm shift, transforming "don't be evil" to "can't be evil". In DeFi, users own their own private keys and participate in transactions directly, eliminating dependence on centralized institutions and greatly reducing the risk of user assets being stolen.
Therefore, the self-custodial nature of DeFi provides users with greater security and trust while reducing compliance fees as intermediaries are no longer required to execute transactions and bear risks.
🚩A clear regulatory framework is needed
As technology continues to innovate and open up new markets, regulators around the world face many challenges. In the financial sector, regulators are busy dealing with various forms of fintech, such as emerging banks, crowdfunding platforms, and gamified stock trading (such as the highly publicized Game Stop stock trading incident earlier this year). In short, a clear regulatory framework is urgently needed to address these challenges.
🚩Need better user experience
In order to make it easier for ordinary users to enter the DeFi field, we need to improve the conversion process between fiat currency and crypto economy. At present, the process of converting fiat currency (such as US dollars, euros, pounds, etc.) into cryptocurrencies still has many inconveniences, is subject to geographical restrictions, and has relatively high transaction fees.
🚩Decentralized properties
To a large extent, "private chains" are a mistake made in the early blockchain wave. Similarly, centralized financial institutions may try to borrow from the DeFi movement and make considerable concessions in the process.
Although they appear similar to other smart contract blockchains such as Ethereum, some chains are actually centralized and focus on providing higher network speeds and low fees, while sacrificing the core attributes of DeFi’s value proposition: permissionless, neutral, and immutable blockchain properties.
While in every technology trend there are "weak" forms of technology that are accompanying it, these are not examples of so-called "weak" forms of technology, but rather misleading marketing.
Some traditional financial institutions, such as commercial banks and large technology companies, may adopt misleading or weaker versions of DeFi instead of researching how to adopt or integrate DeFi.
While these products may bring incremental benefits of efficiency, they fall short of realizing the full potential of DeFi: global, permissionless access to global liquidity, and the complete elimination of counterparty risk.
DeFi is here to stay, and while some skeptics see it as an idealistic movement destined to be relegated to the shadow of the internet, DeFi is likely to become a core part of financial infrastructure, not just for cryptocurrencies, but potentially for all other categories of markets, thanks to its innovations around settlement efficiency, risk management, and accessibility.
The opportunity in DeFi lies in allowing traditional financial services and other companies to focus on their core strengths while sourcing liquidity and products directly from decentralized protocols.
The bottom line is this: every crypto wave attracts thousands of engineers and entrepreneurs, and this is exactly how the DeFi future is being built.
If you have any questions about DeFi, please feel free to ask in the comments section. MeeMee is happy to provide you with information and answer your questions. If you like this article, please [like, comment and forward] to support it. See you next time! 👋
