Decentralized finance, or DeFi, manages financial transactions using cryptocurrency and blockchain technology. DeFi’s mission is to democratize finance. Peer-to-peer relationships will be used to replace old, centralized institutions like banks. These can provide a comprehensive range of financial services, ranging from day-to-day banking, loans, and mortgages to complex contractual relationships and asset trading.
Open and Free Banking Ecosystem
Recently, there has been a lot of buzz about blockchain-based financial innovations. Decentralized finance architecture (DeFi) has the potential to create an interoperable financial system with unprecedented transparency and little reliance on third parties. The new ecosystem generates new financial tools for not only decentralized lending and borrowing, but also for various assets and the unbanked. This facilitates the decentralized trading of crypto assets and tokenized versions of stocks or other real-world commodities.
Other examples of smart contract applications include atomic swaps, autonomous liquidity pools, decentralized stablecoins, and flash loans. DeFi recently dropped $70 billion in TVL, which does not reflect transactions but refers to the total value locked in logs.
Influx of Venture Capitals
Inflows of venture capital bolster the resilience of the DeFi thesis. Many investment firms have sprung up with the goal of developing Web3 infrastructure, DeFi applications, and self-driving business models. In comparison to the previous peak in late 2021, the decentralized finance industry continues to grow in terms of active addresses, venture capital investments, and innovative solutions offering cheaper and faster processing capabilities.
By replicating the existing financial services openly and transparently, intermediaries and their additional fees can be completely avoided. Individual self-determination could also make a comeback. However, early adopters need to be aware that they are “beta testers”. This also includes taking on the risk that banks normally bear. Additionally, most implementations in DeFi are limited to ERC-20 tokens on the Ethereum blockchain. They also heavily depend on pricing oracles and third-party protocols. If a smart contract has a problem or an oracle is tricked, the consequences could affect multiple applications and end users.
Democratization of the Financial World
A transparent, efficient, and decentralized financial system – free of third parties – has enormous potential. DeFi has the potential to pave the way for a more open and transparent future. The Federal Reserve’s main concern right now is regulatory uncertainty. Before open, decentralized protocols’ democratic potential can be fully realized, regulators must first comprehend it. So there is a knowledge and understanding gap that needs to be filled on the path of regulators. This would enable them to come up with relevant playbooks that would guide participation.
DeFi, if properly implemented, could also be viewed as “financial democratization.” If well-known companies had to invest transparently and smart contracts set the restrictions, there would be less need for politics and lobbying. There may be less shadow banking and investment in polluting or otherwise malicious companies.