DeFi: The Edge Between a Useful Tool or Yet Another Hype
DeFi stands for “Decentralized Finance.” It is a general term for many financial applications in cryptocurrency or blockchain geared toward removing mediators’ services.
The name DeFi came to the limelight in 2019 and had been witnessing an increase in popularity ever since. The number of people interested has been rising since then. As of November 2020, over $12 billion worth of assets is locked in various DeFi protocols, which are part of the DeFi ecosystem. At the same time, new DeFi applications keep coming up at higher frequencies. It has led investors to believe that DeFi is to Ethereum what bitcoin has been to the cryptocurrency sector.
What’s the significance of DeFi?
With the DeFi network, people can access an unlimited number of financial products and services, ranging from simple savings products to complex trading platforms. These financial services are made accessible cross-borders while removing the need for any paperwork, credit-score, or institutions. It has made it possible for over 1.7 billion unbanked adults worldwide to access financial services without asking someone for permission.
Also, by removing banks and intermediaries, DeFi made these services affordable and accessible to everyone, making a significant difference in the long run. Also, since it is permissionless, meaning anyone with access to the internet can be a part of this ecosystem. Thus breaking all the barriers. By leveraging smart contracts in a permissionless manner, DeFi platforms allow users to store, borrow, lend, transfer, or do all sorts of things with their money.
Source: Duneanalytics, Coingecko, Coindesk Research
What are Smart Contracts?
Wherever DeFi investing or DeFi coins are mentioned, smart contracts come to mind. Smart contracts are like contracts in the real world. However, the key difference lies in the permissionless concept behind it. Smart contracts are basically incorruptible computer programs that facilitate over a blockchain network. These programs require no human input for them to function. Instead, it is a self-executing program, without any need for a third party. Thus making them immune to human greed or errors.
For example, a group of people can go to a decentralized platform, create a project, set the funding objective, and collect funds from people who share the same belief. If the project manages to raise the fund, the smart contract will release it to the team. The whole process can be facilitated in a decentralized, permissionless manner. In essence, supporters will see what the money will be used for and know if the money raised was utilized for the project. If it was not used for the project, they could ask for a refund, and the smart contract will refund them.
How Can DeFi Reshape the Cryptocurrency World?
The world is programmed in a way that everything is conditioned. That is, there are conditions attached to everything. For example, there are conditions attached to the monthly payment, a credit, or a loan. However, the cryptocurrency world is still dependent on banks to a certain extent. In summary, the world financial system, to a larger extent, is centralized.
For example, Tether stablecoins are backed by traditional currencies held in a designated bank account. It makes no sense to the underlying concept of decentralization since it’s core objective is to remove the middle man, the bank. The current market cap of Tether is above $10 billion, meaning there’s collateral of almost the same amount lying in a bank account. Thus, negating the point.
Here comes the DeFi ecosystem to save us from the banks. You can ask yourself a simple question: who you should depend on, whether the banks or a smart contract.
As most of the DeFi rise is attributed to the Ethereium blockchain network, let’s take an example of it. Ethereum is a blockchain designed to support smart contracts and pushing the exponential rise of the DeFi ecosystem. If Bitcoin can be considered to be the first one, DeFi powered by Ethereum is the second nail in the coffin of centuries of oppression by banks.
Besides promising a brave new world, DeFi also comes with a lot of advantages. These include;
- Free access to financial services. There are no restrictions.
- No risk of censorship since transactions cannot be revoked, and services cannot be stopped.
- Less counterparty risk; Since there are no trust issues, there is no need for third-party confirmation of truth, making it less counterparty risk.
- Incredible transparency. The system is transparent. The system is auditable by anyone in the network.
(Source: DeFi Pulse)
Is it Safe to Invest in the DeFi cryptocurrency network?
Well, the whole DeFi ecosystem is still in a very early stage of development. Looking at how people have been hyping the network, you will be wondering if it’s safe to invest. As of now, it is safe to conclude that the DeFi crypto is still in a nascent age and a risky investment. Many believe that decentralized finance is the future of cryptocurrency, and investing in the technology could lead to colossal gain. However, looking at decentralized finance, you will see that it is difficult for newcomers to separate the good projects from the bad ones. There are plenty of bad actors trying to scam investors under the garb of DeFi projects.
For example; As DeFi tokens increased in popularity through the summer of 2020, many DeFi applications like $Meme $Sushi and several others have crashed and burned, sending the market capitalization from millions to almost zero in a matter of hours. Many other DeFi projects like Hotdog and Pizza all faced the same fate leading to investors losing money.
In summary, the DeFi space is currently full of rug-pull scams and bugs. Since smart contracts are robust and the rules are embedded into the protocol, it means that the rule can’t be changed, making the bug permanent and thus increasing risk.
Is DeFi worth the hype?
It is not a new thing that decentralized exchange has been taking over this year. The number of DeFi tokens has increased recently, leading to experts believing that the niche will have a brighter future.
Recently, the aggregate trading volume on decentralized exchanges fell to $19.4 billion in October. It is a 25% decrease from $25.8 billion in September. A month earlier, we witnessed an exponential growth of over 115% for the same.
Furthermore, Uniswap, a leading decentralized exchange, declared a 128% volume increase in September, reaching $15.3 billion after bypassing its august record.
Another trading platform, FTX’s serum, which was launched in September, reported nearly $50 million in volume barely two weeks after launch, that’s according to CoinGecko. Although these platforms set a new aggregate record, only a few exchanges reported individual growth while most reported losses.
So, it’s fair to say, the DeFi is definitely a new step in the innovation of the financial world. Neither it’s a hollow hype, nor it’s showing a uniform upward trend. It would be hard to make any assumptions at the moment. Only time will tell how successful the DeFi space will be in the coming future.
Source: Dune Analytics, Coindesk research
The primary objective behind cryptocurrencies was the goal of decentralizing power and improving our financial systems to be more transparent and less capable of fraudulent activities. DeFi can be said as a step in that direction. However, the real strength of DeFi is making transactions easier by cutting the dependency on human processes like bureaucracy and paperwork by automating them while cutting costs and improving transparency. `
At the same time, many of the DeFi projects have failed to live up to expectations. Some have even collapsed within days or weeks after launching.
In conclusion, DeFi is indeed a revolutionary step in the direction of the new financial world order. Although still being in an early stage, it’s advisable to keep a close eye on development but not risk any investment.