We have seen the growing popularity of Bitcoin and other cryptocurrencies in the last few years, with new and experienced investors wanting to get a piece of the action. After all, the possibility of a meteoric rise in value is just too good to pass up. In conjunction with cryptocurrencies, decentralised finance (DeFi) applications, smart contracts, and non-fungible tokens (NFT) are likewise gaining ground.
Since cryptocurrency has no geographical boundaries, people are looking for ways that they can invest in the crypto market simply by searching on the internet. In a study conducted by fintech firm BrokerChooser, Singapore ranked 10th among countries which have the most interest and awareness in cryptocurrency and in trading them. The top three countries were Ukraine, Russia, and the United States, respectively. To get the results, the study looked at the total global searches over the last 12 months for searches related to cryptocurrency.
Cryptocurrencies exist because of a technology called blockchain, a distributed database which is shared among the nodes of a computer network, as defined in Investopedia. A blockchain stores information electronically in blocks which are linked together through cryptography, which is why blockchain is known for maintaining a secure and decentralised record of transactions without the need for a third party.
Through blockchain technology, users are discovering a new way to execute financial transactions without traditional financial institutions and intermediaries through the use of DeFi applications.
What is DeFi?
To start, what exactly is DeFi? Decentralised Finance or DeFi is an ecosystem of financial applications built on blockchain technology, most commonly on smart contract blockchains like Ethereum. Smart contracts are computer programs that are executed automatically when certain conditions are met.
According to an article from Binance Academy, DeFi can also refer to a movement with the goal of creating “an open-source, permissionless, and transparent financial service ecosystem.” The resulting ecosystem is available to anyone and operates without a central authority wherein users have full control over their assets and interact through peer-to-peer and decentralised applications.
Instead of going through middlemen—such as banks or brokerage firms—buyers, sellers, lenders, and borrowers can interact with one another directly without an institution facilitating the transactions. According to Investopedia, DeFi systems are designed specifically to remove intermediaries between transacting parties.
With DeFi, users can save, borrow, lend, buy insurance, trade assets, and more as long as they have a smartphone and internet connection. DeFi, a Forbes article notes, aims to democratise finance by replacing legacy institutions and enabling peer-to-peer relationships which provide a whole gamut of financial services—from banking, loans, and mortgages to contracts and asset trading.
Benefits of DeFi
One key benefit of DeFi is providing access to financial services to those who do not have easy access to traditional financial service providers. In a traditional financial system, banks act as intermediaries, while courts provide arbitration.
The Binance Academy article notes that DeFi applications do away with the need for intermediaries and arbitrators because users maintain control of their own funds at all times and the code “specifies the resolution of every possible dispute.” As a result, there is less friction and lower costs involved in providing and using financial products.
A CNBC video explains that DeFi protocols are governed by their own communities called a decentralised autonomous organisation (DAO), which is composed of members who have invested in the individual project’s token and, thus, have a say in the protocol’s future. This removes the control from only one person.
DeFi aims to address a top concern for many: transparency. The crypto industry was born out of a reaction to the 2008 financial crisis, CNBC notes, which is why one of the main goals of DeFi is to give users control and visibility over their own money sans a third party.
Meanwhile, since the blockchain is distributed, all parties using a DeFi application will have an identical copy of the public ledger which records each transaction in encrypted code, according to the Forbes article. This results in a secure system that provides users with anonymity, a way to verify payments, and a record of asset ownership that is almost “impossible to alter by fraudulent activity.”
Impact on the Financial Ecosystem
A key feature of DeFi is that it disempowers middlemen and gatekeepers and enables regular people through peer-to-peer exchanges. For example, ordinary people can lend their savings directly to others instead of putting in a savings account with a bank, who will then lend your savings to other customers and profit from the transaction.
To be sure, DeFi will have a big impact on traditional finance, notes Dr. Christine Parlour, professor at the Haas School of Business at University of California, Berkeley, in an article from The Motley Fool. She says that the fully automated system greatly reduces transaction costs, thus making the current system more efficient.
It is important to note that DeFi is still a nascent industry, where there is minimal regulation or oversight. On top of that, most of the DeFi applications appeal only to a small group of individuals and that time and effort must be spent on user interfaces that appeal to a larger audience, says Dr. Jimmie Lenz, director of Duke University’s Master of Engineering in FinTech and Master of Engineering in Cybersecurity, in the aforementioned article.
With disruptions occurring in various industries, such as medicine, insurance, and retail, it’s no surprise that interest surrounding DeFi is growing. As such, it is important to stay well-informed about the developments in DeFi and how these can impact traditional finance. Certainly, there will be opportunities as there are risks. Regardless of where you are in the finance industry, professionals need to understand DeFi and see how it can benefit you and your organisation.
Join SMU Academy’s Decentralised Finance (DeFi): A New Financial Ecosystem and understand the inner workings of this exciting fintech innovation so you can assess the risks and explore new opportunities. Learn more about the course here.
