Understanding DeFi: the Future of an Alternative to Traditional Finance Episode 2: Key Features, Use Cases, and Opportunity

Author: David Zhao, Investment Analyst at Bridge Point Capital

In this episode, we will continue to introduce decentralized finance, an innovative solution to our current financial system. In addition to reducing costs and improving efficiency, DeFi offers many other advantages that traditional finance does not:

DeFi is Permissionless: anyone with an internet connection and a digital wallet can engage in the DeFi ecosystem and access DeFi solutions without restrictions on geography and amount of funds. Banks, on the other hand, impose strict restrictions on who can open an account and on the types of services one has access to. Over 1 billion people around the world still have no access to banking services, and DeFi welcomes all individuals to the new, open, and permissionless financial system.
DeFi is Transparent: Every completed transaction is published on the blockchain for everyone to review or verify. In other words, everyone has access to the full set of transactions of any entity involved. The source code of the protocols behind decentralized applications is also transparent; everyone can review, edit, or build upon the existing ones.
DeFi is Programmable: most of the DeFi solutions are built upon the Ethereum blockchain and smart smarts. The programmability in DeFi enables developers to create new financial products. Thus, users have access to not only financial services offered by traditional banks, but also innovative solutions related to cryptocurrencies or digital assets.
DeFi is Pseudonymous: no one is required to reveal the identity, such as name, email address, or any personal information, in transactions.
DeFi is Secure and Immutable: blockchain ensures the integrity of transactions. Unauthorized modifications are forbidden in design.

Use Cases

DeFi leverages the power of cryptography, decentralization, and blockchain to provide access to almost all kinds of financial services in a more efficient, fair, and open way, instead of relying on a centralized infrastructure. Despite its early stages, DeFi is experiencing rapid growth with more developers and users engaging in the DeFi ecosystem.

A large number of protocols and decentralized applications have been developed. One of the most popular use cases of DeFi is peer-to-peer (P2P) borrowing and lending. Smart contracts automatically match borrowers and lenders and calculate interest rates based on the ratio of the amount borrowed to the amount of collateral. Borrowers obtain loans by using digital assets as collateral, and lenders earn interest every minute by lending out their cryptos, both of whom are better off. Investors can also put their cryptos in interest-bearing accounts powered by lending pool protocols. Yield farming is available, allowing investors to move their cryptos in different liquidity protocols to earn higher returns. For investors who are interested in trading, DeFi platforms have started to create a crypto version of derivatives whose value is derived from underlying assets, including traditional assets such as stocks, bonds, fiat currencies, and cryptocurrencies.

Opportunity

DeFi unlocks tremendous opportunities for product developers to build decentralized applications across different verticles, thus revolutionizing industries beyond traditional finance. Gaming is one of the industries. For one, investors can participate in a no-loss saving game in which participants get all their crypto back, whether they win or not. Each participant first purchases a digital ticket using the stablecoin, which is then pooled to lend to money market protocol to earn interest as the prize.

Opportunities come with challenges and risks, and DeFi is no different. The fact that the emerging field is not regulated discourages many investors, along with the highly volatile nature of cryptocurrencies. Many issues are in the process of being addressed, and the future of DeFi is yet to be determined. At this point, DeFi’s momentum is not slowing down, and it is still envisioned to be the future of finance, an alternative to traditional finance.