What do you think about when you hear “the future of finance?” Most people envision mobile payments, internet banking, and other cutting-edge technology. What about decentralization, though?
DeFi refers to peer-to-peer finance enabled by decentralized technologies built on the blockchain. From lending and borrowing platforms to stablecoins and tokenized BTC, the DeFi ecosystem has launched an expansive network of integrated protocols and financial instruments.
However, Decentralized finance (DeFi) is currently undergoing soul-searching. Terra’s collapse in May 2022 had a contagion effect on many other DeFi platforms. Subsequently, there has been a widespread perception that DeFi offers little more than circular financing and dangerously leveraged speculation, the type that may produce a domino of bankruptcy and failures. And to our horror, it’s partially true.
Read more about the Terra collapse here
The “crypto-winter”
DeFi has since faced many criticisms. The thrust of all these criticisms is that most DeFi revolves around highly leveraged speculation – users deposited their money into these platforms that promised high yields. The platform, in turn, uses these funds to lend or invest in other projects. However, many such projects were wiped out when the crypto bear market hit in 2022.
Nonetheless, there is a silver lining. Authorities in the crypto and DeFi sectors confirm that DeFi is still a developing field that will grow and consolidate as it evolves. Indeed, many think DeFi will become more integrated with traditional banking in the following years by linking with the Internet of Things, digital ID, and data storage. And the more it does, the less it will be centered on the risky habit of lending and borrowing virtually entirely for speculation.
DeFi benefits from using blockchain technology in various ways, including transparency, which may increase due diligence and assist individuals in identifying and avoiding dangerous financial frauds and damaging corporate practices. Similarly, smart contracts give further protection against rogue actors and fraudulent transactions.
DeFi’s Current Status and Potential
Some reports indicated that DeFi’s growth on the Ethereum blockchain was 780% in 2021. The total value locked (TVL) in DeFi protocols was more than $172 billion by the first quarter of 2022. The future of DeFi rests on the three strong pillars: composability, DeFi insurance, and governance.
Composability
Composability refers to the ability of several components to collaborate to produce the intended result. In the context of DeFi, composability is how diverse protocols and platforms work together to generate new financial solutions. This is not to imply that flexibility has not existed in conventional finance. DeFi, however, takes composability to the next level by allowing the creation of a trustless system.
On the blockchain, users can verify every transaction and activity. Ethereum serves as the impartial settlement layer, with no one entity wielding power. Furthermore, because DeFi is permissionless, anybody may design new financial products and apps that would not be viable with old infrastructure.
DeFi insurance
DeFi insurance is the missing link that will bring DeFi up to speed with traditional finance.
DeFi insurance arose out of need, as indicated by the predicted $10 billion fraud losses in the DeFi business in 2021. Insurance safeguards against unfavourable occurrences in the cryptocurrency sector, such as exchange hacks, smart contract failures, and stablecoin price collapses.
Despite the benefits of DeFi insurance, the claims procedure is still unknown. As a result, additional study is required to evaluate the usefulness of this new instrument.
Governance
Some DeFi platforms reinforce the blockchain community’s commitment to decentralization by making governance tokens available to users.
A governance token gives consumers control over the platform’s protocol, goods, and future innovations. Governance tokens are usually established using decentralized protocols that promote community-driven growth and self-sufficiency.
To make critical choices concerning protocol changes, recruiting, and even governance framework alterations, decentralized networking initiatives require governance mechanisms.
For example, a borrowing and lending platform may use its regulating mechanism to compute the requisite amount. In other words, decisions made by project stakeholders through its governance structure can directly influence the project’s success or failure.
When approached correctly, governance efforts can bring in a new era of decentralized growth and collaboration.
In essence, there remain many defenders of DeFi within the crypto sector. All of them continue to affirm that the space will continue to grow and, ultimately, make good on its promises.
