By Anurag Dixit
Decentralized Finance (DeFi) is a new paradigm in the world of finance that is challenging the centralized status quo. In the traditional financial system, financial intermediaries such as banks and other financial institutions are the gatekeepers who hold the keys to the financial system. They control access to capital, dictate the terms of loans and other financial products, and make important decisions on behalf of their clients. However, DeFi products are changing this landscape by introducing decentralized platforms that enable individuals to take control of their finances and participate in the financial system without relying on intermediaries.
DeFi products have been gaining momentum in recent years, with the total value locked in DeFi protocols reaching $49.06 billion in February 2023. This represents a significant increase from the $1 billion locked-in DeFi protocols in June 2020. This rapid growth has been driven by the many benefits of DeFi products, including their transparency, accessibility, and lower costs in a lot of cases compared to traditional financial products.
In the last 2 years, decentralized platforms like dYdX, GMX have shown great resilience in tough times. While FTX and multiple centralized were limiting or locking operations and withdrawals, decentralised dapps were functioning flawlessly without any major hiccups. While the current scenario of DeFi apps can benefit from a significant latency boost, the system’s transparency is unparalleled.
One of the key benefits of DeFi products is their transparency. DeFi protocols are built on open-source blockchain technology, which enables anyone to audit the code and see how the protocol works. This transparency ensures that DeFi products operate fairly and without the need for trust in a central authority. Multiple questionable projects have been launched by writing notorious smart contracts, but such situations can be avoided by having proper audits and checks around the protocol mechanism. In contrast, traditional financial products are often opaque, with many fees hidden from the client.
Another key benefit of DeFi products is their accessibility. DeFi protocols are accessible to anyone with an internet connection. After an initial onramp into the DeFi ecosystem, there’s no need for multiple middle financial intermediaries. This accessibility means that DeFi products can reach people who are unbanked or underbanked, providing them with access to financial products and services that were previously unavailable to them due to physical limitations. While Neobanks solve this issue to some extent, the nature of asset movement is limited, which is global in DeFi primitives.
Finally, DeFi products are often lower cost than traditional financial products. This is because DeFi protocols operate without the need for intermediaries, which reduces the costs associated with these intermediaries. Additionally, many DeFi products are designed to operate with lower fees than traditional financial products, which makes them more affordable for individuals and now small businesses as well. Major payment processors across the globe are leveraging blockchain technology to provide stablecoin and other crypto transactions to Businesses across the scale. This reduction in friction will, in turn, open markets and opportunities for businesses that weren’t possible before with the restrictions of centralized finance.
Last year the collapse of FTX-Alameda and multiple banckruptcies have highlighted the opaqueness of centralized companies, solutions, etc. Apps aiding decentralized coordination have the potential to provide much better transparency on the organization’s activities and operations. Lack of proper governance was a major cause or red flag that led to the downfall of the FTX-Alameda empire. This is a major challenge that can be solved through transparent and trackable governance tools.
In conclusion, DeFi products are challenging the centralized status quo by providing transparent, accessible, and innovative financial products to individuals and small businesses. However, the risks associated with DeFi products, such as smart contract risk, cannot be ignored. It is essential for investors to conduct thorough due diligence on DeFi protocols before investing in them and for developers to implement robust risk management practices to mitigate the risks associated with smart contract flaws. As the DeFi ecosystem continues to evolve, it is important for stakeholders to work together to build a safe and sustainable financial system for all.
The author is founder, Kunji