Decentralized finance, or DeFi, was first introduced in 2017, and since it has been attracting leading businesses and startups to conduct financial activities.
Whether it is trading in cryptocurrencies, lending, borrowing, or investments, people have started choosing DeFi over traditional centralized financial service providers. It is why the revenue in the DeFi market is projected to reach $26.17 billion in 2024.
But what is decentralized finance, and why is it becoming so popular? How can people use it? If these questions are revolving around in your mind, then this blog is for you!
Quytech has explained decentralized finance in detail. So, read the blog till the end to gain some useful insights about DeFi, a form of Blockchain finance.
What is DeFi – Decentralized Finance?
Decentralized finance, DeFi, is a financial system that is built on the leading Blockchains, like Ethereum, Solana, Polygon, etc.
DeFi allows users to conduct financial activities, such as peer-to-peer transactions, investing in digital assets, lending and borrowing, earning interests, and more, securely and transparently, without relying on third-party intermediaries, like in traditional banking and finance systems.
You would be wondering if there are no intermediaries, then how these financial activities are monitored?
Well, the answer to this is Smart Contracts.
Smart Contracts are digital contracts that have all the terms and conditions coded digitally, and the fiscal activity is conducted automatically when these pre-defined conditions are met.
This reduces the dependency on intermediaries, making it cost-effective compared to centralized finance.
Decentralized Finance: Latest DeFi Market Statistics
Here are some current statistics about the decentralized finance market:
Source: Grand View Research
- The global DeFi market size was worth $13.61 billion in 2022 and is predicted to grow at a CAGR of 46% from 2023 to 2030.
- North America has the highest number of DeFi users, with Europe and Asia representing the next largest user bases.
- Approximately $52 billion of value is locked in DeFi.
- According to reports, there will be around 22.09 million users in the DeFi market by 2028.
The numbers show that DeFi is gaining popularity, and in the coming years, decentralized finance may replace the traditional finance system. Read the next section to learn the differences between traditional finance and decentralized finance.
Key Differences Between Traditional Finance and Decentralized Finance
Below is a comparison between traditional finance and decentralized finance.
| Aspect | Traditional Finance | Decentralized Finance |
| Control and Intermediaries | Centralized control by banks and financial institutions. Relies on intermediaries for transactions and trust. | Decentralized control with no central authority. Minimizes intermediaries through smart contracts and blockchain technology. |
| Accessibility | Access is limited by geographical location, banking hours, and account requirements. | Borderless access via an internet connection, available 24/7 with no geographical restrictions. |
| Transparency | Transactions recorded by centralized institutions. | Transparent transactions are recorded on the blockchain, offering immutable and verifiable records. |
| Security | Relies on centralized security measures, susceptible to breaches and fraud. | Enhanced security through cryptographic encryption, decentralized architecture, and smart contract audits. |
| Innovation and Flexibility | Innovation is controlled by centralized institutions and is slower to adapt to changing needs. | Rapid innovation, permissionless development, and flexibility for new financial products and services. |
| Regulatory Compliance | Subject to complex regulatory frameworks, compliance requirements, and jurisdictional differences. | Regulatory uncertainty, evolving frameworks, and challenges in navigating compliance across jurisdictions. |
| Financial Inclusion | Limited access for unbanked and underbanked populations, excluding marginalized groups. | Increased accessibility, empowering unbanked individuals and underserved communities globally. |
| Speed and Efficiency | Transactions may be slow, especially for cross-border payments, with settlement delays. | Near-instant transactions with automated execution via smart contracts, improving efficiency. |
Hence, these are the differences between traditional finance and decentralized finance.
Now, let’s move on to decentralized finance’s use cases in various industries.
Applications of Decentralized Finance (DeFi)
The following are the top applications of decentralized finance:
- Decentralized Exchanges (DEX)
Decentralized exchanges (DEX) are exchanges where people can exchange cryptocurrencies, NFTs (non-fungible tokens), and other digital assets, directly with other users.
In DEXs, such as Uniswap, Curve, and PancakeSwap, the exchange of commodities is carried out directly between the users. There are no middlemen or third-party intermediaries.
Decentralized finance allows the exchange of assets directly to users in the decentralized exchanges, eliminating the dependence on intermediaries.
- Lending and Borrowing
DeFi has also been used in conducting lending and borrowing activities. In traditional lending systems, people use their assets as collateral to borrow capital from centralized institutions like banks and financial institutions.
This process is time-consuming as it requires paperwork and verification of the borrower’s financial history.
With the introduction of DeFi, the lending and borrowing system has become decentralized. Users leverage digital assets, such as cryptocurrencies and NFTs as collaterals, and borrow capital without depending on the third parties.
- Yield Farming
Yield farming is how users give liquidity to DeFi protocols in exchange for rewards. There are various methods of doing this, but the most frequent is depositing crypto assets into a liquidity pool.
When users deposit their digital assets into a liquidity pool, they provide the required liquidity, allowing smooth trading of tokens on decentralized exchanges. In return, users receive a percentage of the pool’s trading fees as rewards.
- Asset Management
DeFi helps users to manage their assets more efficiently. Thanks to DeFi, users can access asset management strategies powered by smart contracts, designed to maximize returns while minimizing exposure to volatility and other market risks.
Moreover, DeFi enables users to maintain full control of their assets at all times. It eliminates the risk of asset loss or mismanagement compared to traditional asset management services.
- StableCoin Swap
Stablecoin is a kind of currency that is linked to a fiat currency, such as gold or dollars. The link to stable fiat currency (dollars) or commodity (gold) reduces the volatility of these currencies.
DeFi helps users to swap Stablecoins with other users at minimum fees, without the need for intermediaries.
- Metaverse
Metaverse has gained immense popularity in the last few years. Leading businesses like Nike, Gucci, Coco-Cola, and others are building their dedicated Metaverses to engage with customers better and improve sales.
Moreover, to conduct smooth transactions in the virtual environment, top Metaverse development companies are integrating elements of DeFi to offer enhanced buying experiences to their customers.
By leveraging decentralized finance, businesses ensure fast, secure, and transparent transactions as there are no banks or other third-party intermediaries.
- Insurance
Insurance is one of the fastest-growing industries worldwide. In fact, reports show that from 2023 to 2030, the global term insurance market size is predicted to grow at a CAGR of 8.7%.
With the implementation of decentralized finance in insurance, the insurance process gets automated and chances of fraud are reduced, thanks to smart contracts.
Smart contracts have terms and conditions embedded digitally as codes, and when these pre-defined conditions are met, the compensation is paid to the insured, without any hassle.
Hence, these are the top use cases of decentralized finance or DeFi. DeFi offers numerous benefits to businesses as well as users. Read the next section to learn about the benefits of DeFi.
Benefits of Decentralized Finance- DeFi
The following are the top benefits of decentralized finance
- Democratization of Finance
Decentralized finance, also known as DeFi, leverages blockchain technology to create financial systems that allow users to conduct financial activities, such as lending, borrowing, trading, and earning interest, without depending on intermediaries.
This makes financial services accessible to more users, enhances their participation in financial activities, and empowers the overall finance sector.
- Efficient and Faster Transactions
In traditional financial services, the transactions are executed through third-party brokers, like banks, and it takes time to complete a particular transaction. Also, wrong transactions happen due to manual mistakes.
With the introduction of DeFi, these transactions are completed swiftly as there is no dependency on brokers.
Also, these transactions are facilitated by smart contracts, and transactions will execute only if the conditions mentioned in smart contracts are fulfilled. As a result, the chances of errors are nearly zero.
- Reduce Costs
Decentralized finance eliminates the dependency on intermediaries such as banks and financial institutions.
This results in users saving transaction-related fees or charges they used to pay to intermediaries in traditional finance systems.
Additionally, DeFi offers automation facilitated by smart contracts in the financial ecosystem. Thus, this minimizes the need for human resources to monitor the operations, further cutting down operational costs.
- Increased Security and Privacy
DeFi uses blockchain technology to carry out financial activities. And it is proven that data tampering is almost impossible in blockchain technology. Moreover, smart contracts automate financial processes without revealing the identities of individuals.
Additionally, DeFi offers complete ownership of assets to the users. Thus, no one can access except the users themselves, access the digital assets.
- Round-the-Clock Services
Another benefit of DeFi is that it provides financial services 24/7, 365 days, unlike traditional banks which operate for limited hours. The decentralized finance works on blockchain networks like Ethereum, Solana, Tron, etc.
It allows users to carry out transactions, lend or borrow digital assets and cryptos, or participate in trading activities, at any point in time.
- Reduces Fraud and Corruption
Last but not least, decentralized finance helps in reducing fraud and corruption. DeFi is built on blockchain technology, that is secured, transparent, and tamper-proof.
Additionally, the transactions in DeFi are executed through smart contracts, in which terms and conditions are already embedded as digital codes.
Thus, DeFi leaves no open windows to fraud or practice corruption, as all the processes are automated, secured, transparent, and difficult to tamper with.
Therefore, these are the top benefits of decentralized finance (DeFi). However, just like every coin has two sides, DeFi also comes with some risks involved. Read further to know in detail.
Potential Risks of Decentralized Finance
The following are the potential risks associated with decentralized finance or DeFi.
- Smart Contract Vulnerabilities
The operations in DeFi are executed by smart contracts. These contracts have terms and conditions recorded digitally as codes. However, there are chances that these codes can be manipulated by unauthorized persons which ultimately affects the whole DeFi system.
Hence, it is crucial to audit smart contracts regularly and add additional security layers to avoid unauthorized access.
- Operational Risks
DeFi is at its initial stages and there are potential risks associated with it working efficiently. As it is a technology, there are chances that DeFi may face downtimes, user errors, or network congestion.
Hence, we suggest leveraging DeFi platforms that have a reputable history. You can also have multiple platforms for backup which can be used in times of emergencies.
- Liquidity Risks
Liquidity is vital for the smooth operation of DeFi. However, there may be times when required liquidity is not available, and the DeFi ecosystem gets affected.
So, we suggest you keep a tight eye on the DeFi liquidity and be prepared with proven strategies to tackle these kinds of challenges.
- Regulatory Risks
Decentralized finance minimizes the involvement of third-party intermediaries and brokers, such as banks and financial institutions. However, it also exposes DeFi to regulatory risks, as there is no one to regulate the operations.
Yes, smart contracts facilitate transactions but think of a situation where you made a wrong transaction, and due to an error in the codes of smart contracts, it gets successful. Now, you have no option for a refund as there is no regulatory body, unlike in the traditional financial system.
Therefore, it is suggested that users should exercise caution and carefully use DeFi applications and platforms.
So, these are the potential risks associated with DeFi. However, with the right planning, these risks can be addressed easily.
Concluding Thoughts
At this time when technology is changing everything around us, the finance sector has started witnessing a transformation known as decentralized finance.
Decentralized finance is changing traditional financial systems by minimizing the dependency on intermediaries to carry out financial activities securely and transparently.
However, along with benefits decentralized finance also brings some potential risks that need to be taken into account to ensure the efficient working of the DeFi ecosystem.
What are your thoughts on DeFi? Will it replace traditional centralized finance systems completely or not? Do let us know your thoughts in the comment section below.