DeFi Explained: Why Decentralized Finance Is So Important To Crypto – Screen Rant
From lending/borrowing apps, token swaps, NFT marketplaces, automated casinos and more, DeFi provides financial services for cryptocurrencies.
One of the largest applications of blockchain technology is Decentralized Finance, or 'DeFi,' which is dedicated to reinventing the financial system using decentralized and automated technologies. DeFi is the spiritual successor to Bitcoin's purpose, allowing crypto holders to access financial services such as loans, savings, trading and even advanced financial instruments.
The greed and incompetence of the traditional financial system that resulted in the 2008 Financial Crisis led to the creation of Bitcoin and blockchain technology, but Bitcoin lacks the financial services that the financial system provides, and there's no way to build those services without relying on centralized infrastructure. So while the invention of Bitcoin was an impressive feat, it has since been improved upon by blockchain smart contracts pioneered by Ethereum, which enabled programmability for blockchain and paved the way for Web3 blockchain-based internet apps, along with the thousands of cryptocurrencies and NFTs today.
After Ethereum was deployed in 2016, it wasn't long before developers began creating financial services for cryptocurrencies, leading to the rise of 'DeFi.' Investopedia explains that DeFi provides financial services for cryptocurrencies but is still an emerging industry. Rather than relying on banks, DeFi users act as their own banks by approving transactions, safeguarding their assets, and using their crypto in DeFi apps. DeFi is a very broad category, spanning entire asset classes and many types of Web3 apps. Many DeFi apps use stablecoins (cryptocurrencies with a stable value), which have become the lifeblood of DeFi due to their use by crypto lending/borrowing platforms like Aave and their usefulness as a payment method. In addition, DeFi is well-known for its decentralized exchanges, or 'DEXes,' such as Uniswap, which allow users to swap between any two cryptocurrencies built on the same blockchain. While not explicitly DeFi, non-fungible tokens, or 'NFTs,' have found use in NFT lending/borrowing apps as well as by non-NFT DeFi apps that use them to represent crypto deposits, and NFT marketplaces like OpenSea have been a staple of the industry for years for their role in giving NFTs value through trade.
While many 'blue chip' DeFi protocols are considered safe to use (particularly those mentioned above), DeFi is a Wild West of new ideas and experimentation, much of which explodes due to unforeseen complications or gets hit with hackers or crypto phishing attacks. As a result, DeFi has earned a reputation as a gambler's paradise, though DeFi risk depends entirely upon the user's choices and understanding of the concepts they are working with. DeFi has crossed paths with regulators before, who are not amused by the complete lack of KYC (Know Your Customer) and AML (Anti-Money Laundering) policy adherence that all other financial services must adhere to, as well as the inability for DeFi apps to follow such policies due to their immutability.
According to DeFi Pulse, there is currently (Sept. 2022) a staggering $26.3B of assets locked in DeFi smart contracts, and in Oct. 2021, the highest value locked was $45.5B. DeFi is still a niche industry with plenty of "learning experiences" ahead of it, but it could easily become a multi-trillion dollar industry in the future, given its usefulness and broad scope. While DeFi could theoretically pose an existential threat to the existing financial system, the two systems will likely coexist and form symbiotic relationships. As Fireblocks reported, Aave has already jumped on this idea with Aave Arc, a permission lending pool for institutional clients. It seems inevitable that banks will eventually have their own smart contracts to send and receive stablecoins from the blockchain.
DeFi is still a nascent industry that strives to create financial services for cryptocurrencies and blockchain assets, but it stands to become one of the most powerful industries in the world over the next many years. For now, it is a playground for gamblers, geeks, scammers, hackers and visionaries alike, but many DeFi apps have proven their durability and safety, and with better user experience, DeFi will become a major financial technology that everyone uses in some way or another.
Sources: Investopedia, Aave, Uniswap, OpenSea, DeFi Pulse, Fireblocks
Phoenix is a blockchain enthusiast, aspiring smart contract developer, and a student of computer science. Joining Screen Rant’s Tech team in 2022 and leveraging his own technical understanding of the subjects, he reports on the most interesting events and advancements of the fast-paced world of the blockchain industry, Web3, and the emerging Metaverse.