A Beginner's Guide to DeFi
You may have come across the term ‘DeFi’ while exploring the world of crypto. It’s one of the fastest growing areas of crypto, aiming to connect the real-world with blockchain.
In case it’s left you feeling puzzled, let us lay it down for you in simple terms with 7 things you need to know about DeFi.
1. DeFi aims to address the shortcomings of the traditional financial system
DeFi stands for Decentralised Finance and describes the bigger picture behind crypto - an entire financial system (which cryptocurrencies are a part of) built on blockchain technology. DeFi takes the benefits of blockchain and applies them to complex, real-world use cases, by disassembling traditional financial services and decentralising them.
Sometimes referred to as the Open Finance movement, the idea is to give everyone complete control over their own assets and make financial services available to anyone and everyone around the world. This is achievable through the creation of a new ecosystem of financial applications - built upon open-source software and decentralised networks - which eliminates the need for any central, controlling authority or profit-seeking middleman.
Instead of monetary transactions such as trading or borrowing being carried out via an intermediary (like an exchange or bank), they take place directly between parties, through an automatic process. This is possible thanks to programmable, self-executing agreements encoded on the blockchain, known as smart contracts.
2. Most DeFi applications are built on the Ethereum network
Ethereum is probably the best known, fully functioning DeFi network, which is arguably the most flexible to build on. Its scalable open-source software platform enables anyone to create decentralised apps (‘dApps’) on it, using smart contracts that automatically execute transactions if certain conditions are met. In fact, the programming languages used in Ethereum programming languages are actually designed for creating and deploying these smart contracts.
3. DeFi will play a big role in banking the unbanked
There are thought to be 1.7 billion people around the world who lack access to financial services and don’t have an account with a financial institution or mobile money provider.
DeFi has the potential to massively reduce the costs involved in foreign remittance, for one. Without the need for certain intermediaries, over 50% could be slashed off the often prohibitively high fees incurred for sending money abroad. It could also become possible to take out loans quickly and easily, without the need for a credit history.
Recent research by the World Bank shows that over two-thirds of the world’s unbanked now own mobile phones, which could give them instant access to DeFi platforms - if they were widely known.
4. DeFi has been growing a lot in the last few years
Analytics site, DeFi Pulse, shows that the value of the DeFi space has grown from roughly $650 million this time last year to around $40 billion today. This is largely down to improvements in technology linking DeFi and blockchain activities together more easily, as well as a growing awareness of DeFi’s benefits, such as reduced costs, access for all, increased transaction speeds, higher levels of security and greater transparency, to name a few.
The 2008 financial crisis and economic downfall since COVID-19 has highlighted the need for a decentralised economy. Many argue that these issues are largely the result of poor decision-making from centralised authorities, and a lack of proper financial regulation. To prevent a similar situation occurring in the future, and with more real-world use cases for DeFi developing, it’s highly likely that the demand for DeFi will grow.
5. There are a huge range of DeFi applications
The most popular types of DeFi application includes decentralised exchanges, stablecoins, lending platforms, wrapped bitcoins and prediction markets. There are also several DeFi concepts surrounding these applications, including yield farming, liquidity mining, composability and money legos.
Of course, you don’t need to know what all of these do, but know that DeFi has the potential to expand beyond banking solutions. In years to come, the DeFi ecosystem could encompass every aspect of finance - not just transactions made with digital currencies, but digital assets of any kind, such as commodities or even real estate. It could well be the enabler of a token economy.
6. One of the biggest issues facing DeFi right now is scalability
As with any new transformative movement, there are potential problems which need addressing before it can take off on a large scale. One concern is that public blockchains may be unable to handle the volume of transactions that would be required were the masses to get on board, leading to slow transactions and expensive transaction (gas) fees. However, this is being addressed with upcoming changes in the Ethereum network that will help to cater to this demand.
Considering also that current DeFi organisations exist independently of each other in a fragmented market, and each country has wildly different regulations and attitudes towards blockchain and crypto - there’s a long way to go before DeFi reaches all corners of the globe.
However, many argue that DeFi is still not widely accessible to the mass market because users need to have an e-wallet to make use it.
7. Companies like Wirex are making it easy to access DeFi
It’s clear that many DeFi solutions are better alternatives to traditional finance, but one barrier to mass adoption is lack of accessibility and a difficult user experience. At Wirex, we are building a bridge between DeFi and the traditional financial infrastructure through various new features, making it easy for everyone to access DeFi in the everyday.
We also plan to launch our new X-Accounts feature, allowing users to deposit collateral into pots of funds, and automatically receive up to 12% back in crypto.
The future of DeFi looks bright. There’s still some way to go until it reaches mainstream adoption, but when it does, it could do a great deal to address financial inclusion, by putting the power into the hands of the individual - and ultimately aligning with Wirex’s goal of being open to all.