What is DeFi and could it be the greatest finance revolution of all time?
Hi,
This is Maciej Zieliński from Nextrope’s Insights. In today’s newsletter, I took a closer look at DeFi's drastic impact on the modern finance industry. What exactly is DeFi? Why did it gain such significant growth during pandemic?
More specifically, we will focus on:
⛓ DeFi advantages
💸 Crypto Loans
📈 Growth of DeFi in 2020
🔥 Key DeFi trends
DeFi stands for decentralized finance - a collective term used to describe the various financial applications of Blockchain technology aimed at pushing away financial intermediaries. Blockchain allows multiple entities to store a copy of the transaction history, which takes it out of the control of one central source. What does this difference mean in practice? When you pay with your credit card for purchases, financial intermediaries such as your bank, Visa, or Mastercard mediate the transaction between you and the seller, having the right to hold it and register it in your private ledger. Thanks to DeFi, involvement of these institutions isn’t necessary.
What is the advantage of DeFi solutions over traditional ones?
DeFi pros:
Improved security
Exclusive control in the hands of users
Democratization of development
Higher return on investment
Better credit conditions for small entrepreneurs
Blockchain = security
The use of Blockchain technology provides a new level of transparency and security. In DeFi solutions each user can see where their digital assets are stored and how they are used. Security smart contracts are permanently recorded after deployment and cannot be changed. In practice, this means that transactions are only carried out when both parties comply with the terms of the contract.
Exclusive control in the hands of users
Most banks quickly adapt to the online world, tempting users with new applications or solutions that facilitate transaction handling (such as Polish Blik). Yet, money in user accounts is still under the control of the bank. And what it comes to this issue, DeFi looks significantly ahead. Only the owner has the private key to his decentralized wallet and only he has control over the funds therein.
Democratization of development
Changes in traditional finance can take decades. At DeFi, innovations are introduced in real-time, and the development itself reflects the idea of democratizing finance. There is no authority to determine who can enter the new code into the network, so theoretically anyone can do it. Additionally, users of solutions are often involved in the process of voting on changes.
High return on investment
My observations show that in the next few years' traditional finances will remain the most popular place to deposit money. But for how long? After all, interest rates are often lowered more and more every year, and the fees remain the same.
In contrast, DeFi financially encourages users to bet on or borrow assets. The interest that would be taken by the bank when borrowing the client's money is paid directly to the lender. Thanks to DeFi, the user earns interest that the bank usually keeps.
Loans for small enterprises
Loans for small and medium-sized enterprises are one of the most important aspects of traditional finance that need to be changed. It is they who most often face difficulties in obtaining funding. Crypto loans are a way that makes it much easier for them.
DeFi allows peer-to-peer loans to be directly matched to borrowers and lenders. Usually, a crypto loan is secured with a smart contract and cryptocurrency assets. In contrast, the interest rate is based on the value of the funds that the borrower uses as collateral. The loan can be granted in both cryptocurrencies and fiat currencies.
The last Kraken Intelligence report argued that far more than 50% of locked ETH are now in lending protocols. There is no specific data on the current size of the market, yet one of the biggest players - Aave, claimed it processed over $2 billion of loans only in 2020. And several same-sized competitors are offering similar services.
A key factor in obtaining such a loan is the number of cryptocurrency funds that the borrower can establish as collateral. Due to the volatility of cryptocurrencies, loans are very tightly secured. In practice, this means that they require a collateral ratio of at least 150%, which gives the lender some security in risk management. Yet, importantly for small enterprises, the traditionally understood creditworthiness is not taken into account in the assessment process.
Key DeFi trends
In 2020, DeFi saw a gigantic increase of nearly 1,000%, and as decentralized finance continues to gain popularity, the number continues to grow. Which DeFi trends will have key importance this year?
DeFi trends that will rule in 2021
Liquidity of staked tokens
Stablecoins
The growing importance of DEX
At the end of last year, DeFi's total closed value had already exceeded $ 26 billion. For comparison, a year ago, only 831 million were blocked in DeFi protocols. The extremely dynamic development of DeFi in 2020 prepared the ground for the next wave of adaptation in 2021. Because despite such rapid growth, DeFi remains a very young industry with a lot of room for innovation.
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