Decentralized finance: Here’s what you need to know

Decentralized finance

DeFi or, decentralized finance, is an alternative to traditional banking services.  Using innovative technologies like smart contracts and blockchain, decentralized finance operates without the need for a bank, through ‘peer-to-peer’ banking. It’s an industry on the ascension, according to BCC Research’s latest report. Within the next five years, the global decentralized market is set to boom from a value of $9.4 billion in 2021 to $70.3 billion by 2027, with a CAGR of a staggering 39.5%.

What is DeFi?

DeFi is simply a branch of FinTech that takes a more comprehensive approach to decentralizing traditional finance. While FinTech focuses largely on decentralizing money through Bitcoin, DeFi aims to make traditional financial services accessible to everyone by creating an ecosystem of permissionless financial services built on blockchain infrastructure.

Overall, DeFi is an ambitious project. The underlying technology behind it involves a set of protocols or decentralized applications (dApps) on a blockchain. These create a ‘peer-to-peer’ financial network, effectively cutting out the middleman. Users can send money to each other without a bank authorizing the transaction. The financial markets are always open, and fees for accessing financial services are eliminated. It’s a revolutionary way of banking, shifting power away from traditional banks back to the user.

The benefits of DeFi

The foundation of DeFi is a blockchain. DeFi can be seen as a collection of second-layer apps because the blockchain is sometimes described as a general infrastructure layer. DeFi can incorporate the fundamental aspect of decentralization as a result. It is vital to remember that this only applies if the blockchain is decentralized in and of itself.

With this stipulation, there are several key advantages to decentralized finance: 

  • Equity: True decentralization eliminates trusted third parties. The entire globe can partake in finance, regardless of social status and resistance to censorship. 
  • Ease: The immutability of financial contracts, contract automation, and quick and inexpensive transactions/settlements are all made possible by blockchain technology. 
  • Autonomy: DeFi apps typically permit the user to keep control of the private keys. The blockchain ecosystem uses the term “non-custodial” to describe this. Without a responsible third party, the user has complete control over the finances.
  • Efficiency: Improved market and price efficiency is the result of increased ecosystem openness. Principal-agent risks are minimal since there is no asymmetry in the knowledge and a clear protocol governs the individual interests. 

Could DeFi be the answer to the unbanked issue?

According to a Federal Reserve survey report from the beginning of 2021, there are still 1.6 billion adults who are unbanked. The quality of being unbanked (which simply means without an account with any financial service provider), vastly affects people with lower incomes, less education, and Black and Hispanic people. 

DeFi is a radical attempt at finding a solution to these issues. Blockchains make it simple to receive and hold money without needing a bank account, and users of blockchains and DeFi applications are not required to keep a minimum balance. Distributed ledgers are another technical method they utilize to ensure that virtual currencies do not require the intermediary’s trust, as in conventional finance.

DeFi is a safe and effective way of distributing money to people on a large scale. Simultaneously, DeFi lowers exposure to the fluctuations of the traditional financial markets. For example, users in Argentina who received their wages through decentralized banking have managed to dodge soaring inflation. But there are still several key barriers that DeFi must overcome to ensure safe and effective decentralized banking.

DeFi protocol security

Nothing in life is risk-free, and the same goes for DeFi. In the first five months of 2022 alone, financial losses because of DeFi hacking were a staggering $1.4 billion. According to DeFi Pulse, DeFi has a total value locked (TVL) of more than $56 billion. TVL simply means the sum of the value of all assets locked into DeFi protocols. This substantial sum is a steep decline from 2021, when the TVL of DeFi exceeded $110 billion. The recent stablecoin crash is the key instigator for the decline of TVL, but equally, financial losses resulting from protocol vulnerabilities account for some of the damages in TVL. Cyber-attacks, exploits, swindles, and arbitrage against DeFi protocols are rising, making DeFi and increasingly risky exploit.

Learn about the market trends for global decentralized finance

BCC Research has recently published the report: Global Decentralized Finance (DeFi) Market: Trends, Global Scenario, Innovations & Market. The report breaks down the conditions, trends, and challenges that lay ahead for global DeFi, making it an invaluable tool for those hoping to learn more about the industry. Despite its challenges, DeFi is set to make a huge global impact, as reflected by its anticipated market growth. There’s never been a better time to become equipped to navigate this buzzing industry.

Download your complimentary report overview here.

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Written by Olivia Lowden on Jan 19, 2023 9:00:00 AM

Olivia Lowden is a Junior Copywriter at BCC Research, writing content on everything from sustainability to fintech. Before beginning at BCC Research, she received a First-Class Master’s Degree in Creative Writing from the University of East Anglia.

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Topics: Finance, commerce

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