What is DeFi and more importantly why all the hype?
The hottest topic in the crypto world right now is DeFi, short for Decentralized Finance. Even someone such as I who has been living under the hood has heard of it and how it is the next path breaking event in crypto. For those not familiar, Decentralized Finance, or DeFi, is nothing but a term used for a bunch of applications that are using blockchain tech/cryptocurrency and applying the concepts to the world of traditional finance, be it an exchange providing trading services or borrowing & lending or asset management.
In case you did not know, then there was already a big borrowing and lending market for Bitcoin. People who want to short the currency will borrow the currency in the institutional market and sell it, hoping to make money from a fall in bitcoin price. Now with DeFi, another pool of bitcoin liquidity is added to such a market. However, the applications are not just limited to that. Many, if not most, have probably heard of Uniswap.
Then there are other DeFi protocols such as Maker and the likes that creating a money market for cryptocurrencies.
Now, I personally have not yet invested in any DeFi protocol as I am a risk averse crypto investor. That kind of sounds like an oxymoron but what I mean is that I invest when I know the asset has been vetted enough by investors. Even when I haven't innvested, I think the potential for DeFi is huge. Any and every aspect of traditional finance is up for disruption and the groundwork for that is being laid by various DeFi protocols in existence today. Sure, there will be scams such as Kimchi but that cannot take away from the fact the DeFi has the potential to be big one day.
There are a few reasons I am very optimistic of about DeFi. The obvious reason is the potential for disruption in the financial sector that it offers. Now, there are many cryptocurrencies and till cryptocurrencies become mainstream, DeFi by itself will also remain small. However, the potential to take large financial intermediaries and break-up their tasks and ownership to make it all decentralized and more efficient is huge potential. The second reason is that no single entity becomes too big to fail. Users or holders of tokens are owners and they decide the future. The potential for financial fraud is reduced with proper security in place. If you want to purchase an equity security, there are 4 or 5 middlemen - broker, custodian, settlement agent, exchange to name a few. All centralized entities leading to a 3 day settlement process. Think about payments, think about borrowing money. DeFi can bring it all under one roof, under the ownership of token holders, with far better security and technology to make things faster and better.
Even from a crypto user point of view, DeFi brings the possibility of trading non-ethereum assets on ethereum based projects/ethereum blockchain i.e. wrapped bitcoin. Before we get to a point where various blockchains can communicate with each other, we have found a way of bringing cross blockchain liquidity to the crypto markets.
The potential for disruption, decentralized nature of applications and superior infrastructure is what makes me excited about DeFi and we have barely scratched the surface.
I think the most promising applications of DeFi for me at the moment at exchanges and lending platforms. I think DEXes are a brilliant concept to prevent any exchange from becoming too big under a human brain as that is the ground for corrupt thoughts. Also, lending excites me because it helps those who are at the mercy of banks or other non banking financial lenders to access money when they want, all at market driven interest rates. So I think Uniswap is a great exchange application and the team at Maker is phenomenal.
We at this moment should also look at how a DeFi projects work and for that I will use the example of Maker.
Maker is a DeFi protocol built on top of Ethereum blockchain and has 2 native tokens - a governance token called MKR and a stablecoin called DAI. Users can borrow/lend crypto on the Maker protocol and earn or pay in DAI (a USD pegged stable coin). They can also save DAI and earn interest on it and trade DAI on exchanges. The MKR token is a governance token similar to SP that is used for voting on the protocol. Now this is exactly like money markets in traditional finance. You can borrow cash or an asset against another asset and invest the cash or use it as you please. The concept has existed for hundreds of years, except now it is dencentralized.
Here is an interesting case study of Maker DAI -
From the video above, one can understand why I am extremely excited about DeFi. I think but for Ethereum poor network, DeFi has the potential to be huge and I do think it will be on some other smart contact enabling blockchain. Ethereum's layer 2 solution is a dream that will take years to build and I do feel that DeFi will grow bigger on a faster blockchain network. Being from a financial background, I know that my excitement will only grow and DeFi will only get bigger. What do you think? let me know in comments.