Growth of Decentralized Finance (DeFi)

Note: This post has been written by a WazirX Warrior as a part of the “WazirX Warrior program“.

DeFi or decentralized finance is the talk of the town today. The term was non-existent a few years back and today it is creating history. A community of defiant individuals came up together with the goal of creation of a novel financial standard where no third party or centralized authority is involved. DeFi started to get proper investor attention in the year 2018-19 and opened a new horizon! DeFi has almost become a movement now. In 2017, we saw the ICO boom. ICO was an innovation to raise funds from the retail investors but the ICO boom didn’t last long. ICO isn’t a preferred method to raise funds nowadays. Is DeFi another hype in the cryptocurrency space or can it be an epoch-making financial excogitation?

“Not your keys, not your coins” – Crypto proverb

The problem with traditional finance

Traditional finance is dependent on various institutional intermediaries. In case of disputes, institutional arbitrators come into the picture. The power in traditional finance is extremely centralized. When people invest, they pass over the control of their assets to the banks or the custodians of the funds. The process ends up at accumulating control and power at the centre of the system. The system fails often. We’ve already seen the 2008 housing bubble burst. Due to the risk accumulation model at the centre of the system, a single failure endangers the entire ecosystem. Traditional finance is the driving force of the global economy, but it has never been an open system. Transparency always remained an issue. The investors often get peanuts of the profit whereas the intermediaries take an enormous cut. Participation in traditional finance was never holistic. The major part of the society doesn’t access the stock market and we still talk about banking the unbanked in the 21^st century.

The programmable money

DeFi aims to create an open-source, permissionless, participatory and transparent financial ecosystem that operates without any central authority. The users always control ownership of their assets and interaction with the ecosystem happens through the peer-to-peer process and decentralized applications (DAPPs). DeFi smart contracts are publicly auditable and thus provide immense transparency. These smart contracts are interoperable also. DeFi’s modular framework allows interoperability and amalgamation of different parts of DeFi to create new functions. DeFi is dynamic and ever-evolving. DeFi’s trustless feature is attracting both individual and institutional investors nowadays. New opportunities are being created every day. DeFi can be broken up into different categories – lending & borrowing, DEX (Decentralized Exchanges), derivative, layer 2 payment networks (ex- Bitcoin lightning network, WBTC), tokenized assets and asset management (ex-WBTC, Set protocol). The smart contracts managing DeFi are financial robots.

The first half of 2020 was financially depressing and global financial market turmoil spread to the cryptocurrency industry too. There was stress on all kinds of asset classes and DeFi TVL dropped to $500M during the ‘Crypto Black Thursday’ crash on 12^th March 2020. Since then DeFi TVL has jumped 840% to reach $4.7B. The parabolic growth of DeFi was fuelled by the higher interest rate of DeFi than the traditional financial system.