Decentralized finance development makes use of blockchain technology and offers access to financial services for everyone in the world without the involvement of any intermediaries. It mostly operates through DApps on platforms like Ethereum. It is permissionless in nature and uses public distributed ledgers in its daily operations. It covers majorly borrowing, lending, investment, payments, insurance, trading, and asset management.
➼ According to DeFi pulse, which closely tracks the industry, a whopping $14.17 billion have been allocated for various projects.
Some of the heavyweight projects include MakerDAO, Compound, Aave, Uniswap, Synthetix, and Balancer.
➼ Ethereum has the largest number of applications, user activity, and in volume traded.
➼ EOS possesses a huge transaction volume.
➼ Bitcoin has a successful DeFi application named the Lightning Network. It offers instant payments enforced by smart contracts, is scalable, charges very low fees, and offers cross-chain atomic swaps.
➼ DeFi will get a big boost if Ethereum 2.0 is successfully launched in December 2020. It will optimize the network architecture without compromising on security and scalability.
⇝ It is highly resistant to transaction censorship by the different central authorities. This ensures worldwide participation without any economic and social discrimination by eliminating the role of third parties from the system.
⇝ The user has full control over his assets through his private keys. He need not deposit his funds anywhere and the system is non-custodial in nature.
⇝ Price and market efficiency is ensured as principal-agent risks are minimized and all the personal interests are governed by a well-defined and transparent protocol.
⇝ Users can become part of DeFi projects without even having a bank account or a valid credit score.
• The entire DeFi ecosystem is still undergoing a lot of technical experiments and innovation. The user experience offered is still unintuitive.
• Centralized financial systems possess more liquidity than DeFi projects. Liquidity is critical as it acts as the backbone of price efficiency.
• Since there is no credit score requirement, the products are overcollateralized. This reduces the leverage for professional traders.
• In case there are any bugs in the smart contract in the form of overflows, underflows, and reentrancy attacks, it can lead to false or fraudulent transactions which are irreversible on the immutable blockchain network.
• Operational risks are also present if there is a failure or manipulation of price feeds and complex governance protocols.
• Ethereum is facing some network congestion issues which leads to delay in processing transactions contributing to market inefficiency and problems in distributing information to the different participants on a timely basis.
• Since transactions compete directly with each other based on the amount of gas fees, transactions with lower gas fees may be left pending at lower priorities.
Borrowing and lending - With a huge increase in business activities, the need for credit has skyrocketed. Lenders can offer cryptocurrencies to the borrowers and receive interest income regularly. The borrower has the option to short an asset and create leverage. Dharma is one of the popular DeFi lending protocols where more than 2000 different assets are available and it also offers a non-custodial smart wallet with more than 4 million token pairs.
Stablecoins - Stablecoins emerged out of the need to counter the extreme market volatility in cryptocurrencies. It will generally be pegged to a leading fiat currency. MakerDAO offers a stablecoin named DAI which is a decentralized currency with a stable price governed by smart contracts and can be used in games, wallets, and DeFi platforms.
Decentralized exchanges - Cryptocurrencies can be directly exchanged between a buyer and a seller without any control by central authorities. IDEX is a popular decentralized exchange which has a high-performing matching engine and accepts advanced order types. The funds can be handled by a private key and are safeguarded by an open-source smart contract.
Derivatives, exotic assets, and prediction markets - It offers advanced financial instruments like index tracker, puts and call, and futures. It can be used for leverage trading and risk management. Synthetix is a popular derivatives liquidity protocol and users can gain on-chain exposure to a variety of assets. Rewards will be earned by providing collateral to the Synthetix protocol. It offers derivatives trading, staking, and decentralized asset management.
Insurance - The need for insurance has increased these days owing to the huge number of risks and uncertainty present around us. DeFi insurance projects protect users from various contingencies like price risk, counterparty default risk, technological risk, and network risk. Etherisc is a well-known insurance platform which offers different kinds of insurance like flight delay insurance, hurricane protection, crop insurance, social insurance, collateral protection for crypto-backed loans, and crypto wallet insurance. It has mainly three platform layers, a generic insurance framework, a decentralized insurance platform, and a decentralized insurance protocol.
With more digitization and adoption of blockchain technology, DeFi will witness widespread usage in the years to come. It needs more professional management and has to cater to a wider target audience and not just blockchain enthusiasts. The main roadblocks are low liquidity, intuitive user interface, capital inefficiency, hidden technological risks, and regulatory uncertainty.
It can play a huge role in cross-border interconnectivity. The main ways in which Decentralized finance solutions will change conventional financial systems are in the form of decision making, risk-taking, and record keeping. Many institutional investors are moving to DeFi these days to break free from the outdated and inefficient traditional financial system.