DeFi: Should Wall Street be worried?
DeFi (decentralized finance) has recently seen robust development and exciting use cases. The focus is on the development of financial applications, such as payments, savings, investments and loans, which are decentralized.
This means that there are not many links with traditional banking infrastructure, which involves managing and maintaining physical infrastructure and staff, sometimes around the world, to provide financial services to customers. . The reason is that DeFi is built on blockchain and crypto technology.
While this certainly has the potential to disrupt the traditional financial services industry, the market opportunity is also enormous. For example, PayPal CEO Dan Schulman estimates that the size of the digital payments market could reach $100 trillion.
Let’s take a closer look at DeFi and what it means for the financial services industry.
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What is DeFi?
The financial services industry is one of the biggest consumers of computer systems. This allowed for more efficiency and scale.
But there are still problems. After all, there are still a myriad of intermediaries like brokers, merchant bankers, market makers, etc. that add to the frictions and transaction costs.
Then there is the issue of access to financial services. Often you need a strong credit rating or a long history to get capital. The result is that many small businesses are undercapitalized. There are also millions of consumers who do not have access to affordable credit.
Granted, FinTech (financial technology) companies have tried to democratize financial services, but apps still use existing banking infrastructure. Consider peer-to-peer payment app Venmo, which connects to existing gateways for any payment. In fact, for a user to create an account, he must provide information about a debit card, credit card or bank account.
But with DeFi, there is a completely different approach. Based on the blockchain, anyone can participate in the network as long as they have an internet connection. This peer-to-peer structure means that there is no middleman, like a bank, to determine whether a loan should be issued and payment made.
DeFi software is based on dApps or decentralized applications. They typically run on the Ethereum blockchain and use smart contracts, which securely store transaction information.
“These contracts are blockchain-based programs that automatically execute actions once agreed-upon terms are met,” said Ramanathan Srikumar, Head of Solutions at Mphasis. “Users can become participants and shareholders of the blockchain system by earning tokens, and the user has control and ownership of their data.”
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What can you do with DeFi?
With DeFi, you can perform all possible transactions with the traditional financial system. The technology is also highly composable (you can interact with the protocols in seemingly endless combinations) and permissionless.
“If someone has an idea for a new kind of financial instrument that doesn’t exist in DeFi, they can use and combine the existing suite of DeFi primitives to bring their new idea to life,” said Nick Emmons, co. – founder and CEO of Upshot. “This kind of permissionless composability, in the form of ‘silver legos,’ has led to jaw-dropping rates of innovation in the DeFi space.
“Innovations that could take years to materialize in traditional financial industries can take weeks or months in DeFi.”
The technology also enables much faster transactions globally and lower fees. As a result, there are more opportunities to earn higher returns compared to traditional banks.
Although the advantages of DeFi are clear, there are still considerable risks. When it comes to people’s money, they want solid guarantees. This is why the US government has strict regulations on the financial sector and protections like deposit insurance.
“DeFi essentially replaces the role of the intermediary and regulator in consumer protection with smart contracts,” Emmons said. “This substitution puts more of a burden on people who interact with these financial products to exercise due diligence, ensuring that there is no potential for technical exploits in smart contracts.
“Most cases where consumers have lost money in DeFi to date stem from technical vulnerabilities that were then exploited.”
According to a report by Elliptic, there were more than $10 billion in funds stolen from DeFi accounts in 2021. This is 7 times more than the following year. By comparison, $247 billion is deposited in DeFi accounts.
The future of DeFi
DeFi is still in its infancy, with adopters willing to take risks and embrace new approaches. But if DeFi is to become more mainstream, it will need improvements to make the systems easier to use as well as protections to keep users financially secure.
Although, in the next few years, much of the growth in DeFi may come from emerging and frontier markets. They struggle the most with traditional finance and need better systems to help improve economic growth.
“We are seeing the emergence of a new gig economy in Kenya,” said Jackie Bona, CEO of Valora. “Workers earn their crypto paychecks in real time and use their crypto earnings to pay for daily expenses and use DeFi tools to save and earn more crypto.”
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