DeFi Clarified

DeFi Investing Mar 31, 2021

DeFi sounds similar to defy. Well, in a way, it is defiance to inefficiencies in traditional finance.

While some think DeFi is a great financial revolution, others see it as an opportunity to make fortunes. But it’s too premature to call DeFi a revolution and too shallow to view it as a money-making instrument.

Like most blockchain technologies, DeFi is misunderstood, overhyped, and complicated. This tweet sums it up better:

If you are confused with such cluttered explanations, here’s DeFi explained simply.

About DeFi

DeFi is short for Decentralized Finance, an umbrella term for financial services offered by decentralized blockchain applications. Currently, most of DeFi services deal with cryptocurrency exchanges, deposits, lending, and borrowing.

Though DeFi services sound similar to services offered in traditional finance, they are as different as chalk and cheese. DeFi has innovative solutions like Automated Market Maker (AMM), Smart Contract based insurance, and Flash Loans.

DeFi solutions are transparent. Anyone in the world can transact on DeFi without boundaries. Every financial record is tamper-proof. And no one needs to worry about user privacy.

By running solely on blockchain networks, DeFi eliminates the need for any financial intermediaries. It is resistant to government regulations and independent from any firm’s management or central authority.

Like Bitcoin fundamentally shifted our perception of money, DeFi can potentially do the same for the financial system.

Here is the Oxford Dictionary's definition of Finance: the management of large amounts of money, especially by governments or large companies. Sorry Oxford, you're losing accuracy.

The transaction in DeFi rose astronomically in less than two years of its existence. More than USD 50 Billion is invested in terms of a popular metric called Total Value locked (TVL). But we don’t think this number represents what “value” DeFi brings. There's a lot more to DeFi than the skyrocketing TVL.

Let's look at DeFi closely to understand it better. Shall we?

The ascent of DeFi

DeFi—much like the origin of banking—started with lending. MakerDAO, a decentralized organization, launched lending services for its stablecoin DAI. Users could borrow DAI tokens with the interest, fee, and repayments terms written on a Smart Contract. So here it was, the introduction of finance on the blockchain.

Later, DeFi based applications launched more sophisticated services like Flash Loans. Using Flash Loans, users could borrow and return any cryptocurrency in a few seconds to profit from crypto arbitrage.

At the time of writing this article, more than 2.5 million users (unique addresses) have used DeFi services. The users keep growing exponentially every day!

Of vanity and value

Financial services like Flash Loans and Liquidity Pools add more value and bring more efficiency to the DeFi ecosystem.

For example, providing Flash Loans services offered quick collateral free loans to arbitrators. Decentralized applications and their depositors earn cloud earn fees for lending services. And arbitrators helped reduce the difference of cryptocurrency prices between the exchanges. It’s a win-win for everyone in the DeFi ecosystem.

We think it's wrong to indicate the value of DeFi using TVL. To us, TVL is a vanity metric. TVL doesn’t show any value but is an estimated worth of investments (with shortcomings).

The value of DeFi is intangible. What it is worth is quite difficult to calculate.

A revolution under construction

DeFi is the new kid on the block. The tech, in our opinion, is like the internet in the early 1990s.

Is DeFi the future of finance? We love to think so.

Most DeFi services today cater for purely crypto transactions rather than real-world services like business, consumer, or government borrowing. We also cannot ignore that a few DeFi applications were hacked. Yet the technology has the potential to take any such negative feedback and become stronger.

When compared to traditional finance, the pace of innovation seems to be faster in DeFi. On the other hand, traditional finance is still more accessible.

However, traditional institutions use the regulatory framework to create barriers to entry for new players to compete, this is ripe for disruption.

The road ahead is difficult for DeFi, as sovereigns feel their inalienable right to control the economy. Powerful nations use their currency as a proxy power of dominance, which takes a political turn.

DeFi is disliked by both authoritarian and centralized democracies; they feel an existential threat they will try to ban it, malign it but once people acknowledge its potential there is no looking back.

In short, DeFi is a technical revolution but not a financial revolution yet. It did not disrupt traditional finance. And there are still several technical and non-technical hurdles to cross.

The future of DeFi: facts vs fiction

DeFi is far from its true potential. That’s the only fact. And the rest is fiction.

Since everyone is fantasizing about the future, we came up with our version — Decentralized Capitalism (DeCa). Here’s a glimpse of it:

Imagine a clerk working in California who lends money to an entrepreneur in Vietnam using a DeFi application. While the clerk anticipates great returns, borrowed capital helps the entrepreneur purchase machinery and hire talent for her dream venture. No borders or regulations. Fully democratized and decentralized venture capital.

We have faith in DeFi. Anyone can think creatively as we do. What’s the future of DeFi? Only time will tell.



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