Decentralised finance paves the way towards a more democratic financial system

Around a decade ago, the global Decentralised Finance (DeFi) movement started to develop financial applications that no longer required traditional central financial intermediaries such as banks and exchanges.

The DeFi movement is based on the disrupting perspective that existing financial products and services can be recreated, utilising a decentralised architecture, that operates without the control of centralised companies and governments. Instead, the products and services leverage existing technology-based protocols, smart contracts and cryptocurrencies. In effect, DeFi can offer anyone with an internet connection access to a global and open peer-to-peer alternative to the current financial system. As such, DeFi has significant disruptive potential and is poised to impact the current financial system and its players in markets such as international remittance, lending and borrowing, derivatives, payments and asset transfer.

Looking at the Total Value Locked (TVL) in the smart contracts of all projects – which is the common measure of DeFi’s success – indicates that the movement seems to be gathering momentum. LTM grew by a factor of 20 to approximately USD 16 billion in 2020, and that growth is clearly still accelerating rapidly as the TVL currently stands at USD 66 billion (as of 30 April 2021[1]). To put this in perspective, this is approximately 6% of the valuation of Bitcoin.

The primary added value of DeFi is that users no longer have to place their trust in financial institutions, which are often accused of being too opaque and complex for customers to scrutinise. With DeFi, trust is an insoluble part of the code which is quite often open source and thus transparent. This greatly reduces the likelihood of corruption or manipulation within the system. Therefore, DeFi could be described as a move from ‘institutional trust’ towards ‘infrastructural trust’.

Moreover, DeFi could enable people to gain access to a wider range of financial services, irrespective of their country of origin, their financial status and other traditional parameters. In terms of regulation, the focus is merely on the so-called ‘on and off ramps’, i.e. where fiat money is exchanged for crypto tokens. Typically, these are the institutional exchanges (e.g. Coinbase, Gemini, Kraken) which have become regulated in the past years.

Due to the underlying technology and infrastructural trust, DeFi-based products are in principle more affordable, more efficient, more secure and more easily available to a greater percentage of the population. This reduces the number of unbanked individuals and makes it a more inclusive and digitally sustainable monetary system than the traditional one. For example, in contrast to 0% interest rates for savings accounts in the regular financial system, savers with DeFi products can currently earn 5-15% annually on their digitised dollars. Similarly, thanks to removing unnecessary intermediaries, DeFi-based services can offer significantly faster and cheaper funds transfers, opening up benefits for senders and recipients alike.

However, decentralisation is not without risks and challenges – especially at such an early stage in the product life cycle. For instance, although blockchain technology itself is secure, a proper and adequate approach to the governance, security and quality of the code and the smart contracts is essential. Additionally, access to DeFi products requires the use of cryptocurrencies, which many people still find difficult to understand. Nevertheless, DeFi is expected to continue to expand exponentially as cryptocurrencies become more widely adopted and more blockchains are developed.

[1] Source: www.defipulse.com