Decentralized finance, or DeFi, is an exciting, emerging market that has incredible potential for growth and wealth generation. Its market cap has grown over 1000% between 2020 and 2021 and shows no signs of slowing down, with new protocols and services being added to the ecosystem every day. (1)
While DeFi can be intimidating to navigate—what are DEXs, DAOs, DApps, and smart contracts, anyways? (Hint: read our DeFi 101 whitepaper)—you don’t need to be a programmer or a VC to benefit from this exploding market. You just need to understand what it is, and what it’s trying to be.
The promises and potential of DeFi
To start, let’s try and grasp what DeFi, in theory, actually promises to do. You can think of DeFi’s elevator pitch as something like this: creating decentralized, transparent, trustless, more efficient alternatives to current financial services. It sounds innocuous, but when you take a step back to consider what that means, the implications are pretty exciting.
What if banks were replaced by decentralized protocols that allowed people to lend and borrow peer to peer with limited fees and better terms? What if you could buy and trade options and futures contracts without the need for a clearing house or middleman? What if people could send remittances back to family members overseas without friction and having large parts of it go to companies like Western Union?
Of course, it doesn’t end there. Think of all traditional financial services—all $1 trillion worth of them.(2) There’s probably a group of programmers trying to find a decentralized solution for it. And there’s probably a growing market for that solution.
It’s easy to get ahead of ourselves and think about how much DeFi could disrupt in traditional finance in the future. This change is not going to happen overnight, but DeFi has already made serious inroads into challenging centralized crypto services.
Exploring how DEXs disrupt tradition
At the forefront of this push are decentralized exchanges, or DEXs. These are places where traders and investors can buy and sell different digital assets without the need of an intermediary. Smart contracts are used to execute trades, and users are incentivized to provide liquidity to these protocols so that the whole system can be self-sustaining.
DEXs like Uniswap and Pancakeswap (great names, right?) have risen rapidly. Uniswap had a Total Value Locked (TLV) of $200,000 in 2018. Today, it sits at just under $8 billion. This growth has been incredible. However, when compared with some of the largest centralized crypto exchanges like Coinbase—which has a market cap of $56 billion—or Binance—estimated to be worth $300 billion—DEXs still have a lot of room to grow. (2)
The future of financial services
Borrowing/lending and liquidity providers such as Aave and Compound have also been on the rise. Think of these protocols as financial service providers but instead of a centralized entity (e.g., a friendly neighbourhood bank) putting up the money, it’s the users of the platform. Both these protocols have seen significant rises in the value of their native tokens. Aave alone has a TVL of close to $14 billon. Their native token AAVE went from being worth $50 in 2020, to a high in the 500s in 2021. They’ve proven to be a highly popular alternative to their centralized counterparts like BlockFi or Celsius.
Platforms like Uniswap and Aave have received a lot of attention, and they are excellent examples of what DeFi is doing right now. However, looking long term, they are likely just the tip of the iceberg. Decentralized insurance protocols for digital assets and decentralized crowdfunding have all been getting the DeFi treatment. For people in the developing world, there are also new projects sprouting up that promise to revolutionize the remittance market. (4) In short, DeFi is just getting started.
The dangers of DeFi
Of course, DeFi isn’t all wildflowers and butterflies. To rephrase a famous saying: with great reward, comes great risk. Putting aside the fact that much of DeFi is just not accessible to non-crypto savvy people (“this is called Yield Farming, grandma”), the reality is that like any nascent, unregulated market, there are going to be dangers.
Bugs in computer code have seen millions of dollars of crypto lost. Hackers have exploited poorly audited smart contracts. Scammers and bad actors are prevalent in the space. (5) And that’s on top of the fact that even if everything goes right, you are still dealing with an incredibly volatile asset class. You can’t be too careful, and you can’t play with money you aren’t comfortable losing.
Remember this is still early days
As accessibility and reliability improve and the technology evolves, large-scale adoption might not be too far off. That’s something to get excited about.
–Haan Palcu-Chang, Crypto Content Specialist
–Josh Bubar, VP of Product at Purpose Investments
1. “The explosive growth in DeFi…”, Business Insider: https://markets.businessinsider.com/news/currencies/defi-growth-ethereum-mainstream-adoption-jpmorgan-decentralized-finance-2021-11#:~:text=From%20a%20volume%20perspective%2C%20JPMorgan,similar%20to%20a%20robo%2Dadvisor%20
2. “DeFi can be 100 times larger than today in 5 years”, Cointelegraph: https://cointelegraph.com/news/defi-can-be-100-times-larger-than-today-in-5-years
3. “Former Binance execs say exchange is worth $300B: Report”, Cointelegraph: https://cointelegraph.com/news/former-binance-execs-say-exchange-is-worth-300b-report
4. “WITTY Is Building the DeFi Remittance Platform to Become the Crypto Gateway for Africa”, Yahoo!Life: https://ca.style.yahoo.com/witty-building-defi-remittance-platform-213600775.html
5. “More than $320 million stolen in latest apparent crypto hack”, CNBC: https://www.cnbc.com/2022/02/02/320-million-stolen-from-wormhole-bridge-linking-solana-and-ethereum.html
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