DeFi a.k.a. decentralized finance is here to over throne traditional banks, yet the billions of dollars worth institutions are still blind to the new age of finance.
What are the services that come to your mind when you think of a traditional bank?
- Checking accounts
- Loans
- Savings accounts
- Debit and credit cards
- Merchant services (credit card processing, reconciliation, and reporting, check collection)
- Treasury services (payroll services, deposit services, etc.)
Or whatever you can think of as a financial service that a bank provides is called decentralized finance, in short DeFi, when you use a blockchain to automate them. To be fair, this is a fundamental definition and deserves some further explanation to concretize its potential in your mind.
DeFi consists of many enablers, like digital assets, financial smart contracts, protocols, and decentralized applications (DApps)(Defi Pulse, 2019). A unique combination of these enablers makes different use cases possible.
The most popular use cases are money lending, derivative trading, decentralized exchanges(DEXes), swap channels, and payments. Currently, most of these alternatives are running on one of the most famous public blockchain, Ethereum.
Banks vs. DeFi
The main difference with getting these services from the banks and the DeFi apps is that in a bank, you have an intermediary, a person working in a bank, making the service possible, and giving the decisions for the details of your service. Mainly, there is most of personal initiative and ambiguity is involved.
However, the details of a DeFi service are being programmed in a smart contract at the agreement initiation. Then neither the service provider not the customer can change the details of the settlement details.
To be more concrete, if you’ve locked your one token in a DeFi service to receive a 5 percent return after a year, the smart contract will automatically settle the contract by sending 1.05 token to your wallet after a year.
Currently, the total value locked in DeFi products is around $1.65 Billion. It may not be a huge number compared to the trillions of dollars in traditional financial services. However, considering how pre-mature the DeFi technology still is and the knowledge on DeFi products is quite limited, I would consider it quite a significant achievement not to be overlooked.
Top DeFi Products
If we look at the list in detail top, 10 DeFi products can be listed as:
As you may see in the list, Top 5 DeFi apps hold most of the DeFi capacity in hand, yet these top 5 offer three different services, lending, derivatives trading, and decentralized exchanges(DEXes).
Most of these services have their ERC20 tokens and distributes the rewards in their tokens, which drives the value of these tokens to higher values. Therefore, as long as the product is getting popular, you’re not only gaining from the percentage increase in the number of tokens but also the USD value of each token’s worth.
Of course, there is no promise of a constant rise in token value, and this may also lead to losing value even if you get more tokens on the day of the settlement.
A Success Story: Compound
Especially the top DeFi product, Compound, in this list, has quite a success story, considering it had only around $100 Million as of 15th of June 2020, and just in two weeks, the total locked value in it has reached $650 Million. That is almost x7 in only around 15 days.
This remarkable success is mainly driven by advantageous interest rates offered by Compound over almost negative interest rates the traditional banks can offer.
Downsides
Although DeFi products benefit from most of the security features blockchain provides, they have separate codes, which brings different vulnerabilities.
They are pretty much more centralized 2nd layer solutions. Therefore, these apps can be hacked, and if you don’t believe in the teams developing these solutions, don’t trust them with your money and lock your savings in their solution.
Quite recently, a DeFi liquidity provider Balancer is hacked, and $500K worth tokens are stolen. The team told that they were not even aware of such a sophisticated attack was possible(CoinDesk, 2020).
If you’re curious about the technical details of this attack, I recommend you check out the following piece from 1inch: Balancer Pool with STA Deflationary Token Incident
At least two Balancer multi-token pools were drained for more than $500k today by using a vulnerability in context of…medium.com
Another disadvantage of DeFi is that it’s quite a pre-mature tech and not well regulated yet. Therefore, they are still able to deliver returns above the traditional banks. Yet, the regulation will eventually come for them as well, then these rates of returns will be less likely to be offered. Also, a non-regulated environment generally means more scammers are attracted to the field to hunt.
Key Takeaways
In a nutshell, the DeFi products are here to lead a paradigm shift in financial services. It’s the new hot topic of the Blockchain ecosystem after ICOs(Initial Coin Offerings), IEOs(Initial Exchange Offerings), Smart Contracts, etc.
The more Blockchain technology evolves, the more exciting news we’ll be coming across, yet it’s still vital to go the extra mile in your due diligence and avoid investing in experimental financial products more than you can afford to lose.
Therefore, it’s too early to declare the DeFi applications as an alternative to traditional banking services yet. However, the remarkable speed they are evolving and improving for the better each day, the banks have every right to feel threatened.
If you’re interested in Blockchain innovations, check my piece below about the Layer 2 Blockchain scaling and how beneficial it can be for the gig economy.3 Potential Benefits of Layer 2 Blockchain Scaling on The Gig Economy
Let’s have a look together on how blockchains should scale and what are the impacts of Layer 2 scaling on the Gig…medium.com
Till next time!
Originally published at https://www.datadriveninvestor.com on July 17, 2020.
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Disclaimer: This article is provided for informational or educational purposes only and is not any form of individualized advice. Use this information at your own risk.
References
What is DeFi? — DeFi Pulse
DeFi is an abbreviation of the phrase decentralized finance which generally refers to the digital assets and financial…defipulse.comHacker Drains $500K from DeFi Liquidity Provider Balancer — CoinDesk
“We were not aware this specific type of attack was possible.” Decentralized finance (DeFi) liquidity provider Balancer…www.coindesk.com
