What is DeFi?

Decentralized Finance (DeFi) is a pathbreaking technology. Every stakeholder from investors to enterprises, to customers is empowered with financial freedom and control without the need for intermediaries like banks and third parties. Whether you are from BlackRock or among the 1.4 billion who are outside the financial system, you can access a wide range of financial services like lending, borrowing, trading, and investing without bottlenecks. Opening opportunities for unbanked and underbanked economies. Before it was called DeFi, the idea was rightly called ‘open finance.’

Hitch a ride into the DeFi ecosystem where the power rests in the hands of every participating individual. For the economy everyone deserves.

Key characteristics of DeFi

“At their core, banks sell the utility of resources and the stewardship of resources.”

― Hendrith Vanlon Smith Jr, CEO of Mayflower-Plymouth

The top two goals of DeFi are to reduce transaction times and increase access to financial services.

In this aftermath, the fundamental concept of banking evolves. Instead of solely selling utility and stewardship of resources in an unequal social fabric, DeFi empowers individuals to access, manage, and trade, resources with greater control, transparency, and efficiency in financial transactions.

For banks, the only way forward is to embrace their new role as facilitators, offering guardrails of support within this decentralized ecosystem with robust infrastructure, secure tech, and reliable ecosystem partners. This redefines the purpose of banks and how resources are handled. It also harnesses open-source code allowing anyone to build on pre-existing applications in a permissionless, composable manner.

The key characteristics of DeFi include:

• Decentralization: While there is no central authority or third party, this is not only a dispersal of power but also a dispersal of risk. If a company holds customer data in one spot, a hacker only needs to access that site for a vast amount of data. Storing data across several locations or removing a singular point of vulnerability improves security.

• Open & permissionless: Anyone with a decent internet connection can have entry into the DeFi ecosystem without discrimination, censorship, or permissions from monetary authorities.

• Interoperability: DeFi protocols can be designed to be interoperable for seamless processes and integrations both on-chain and off-chain from fiat to crypto and vice versa. The use cases pan out into more sophisticated financial applications to tackle complex socio-economic issues. While maximizing efficiency and utility for everyone.

• Programmability: As the legos of DeFi, smart contracts are predefined rules of code on the chain that allow automation of financial processes, and instant feedback from users across lending, borrowing, and trading with disintermediation and without complete redeployment.

• Transparency & Auditability: DeFi transactions are transparent and recorded on a public blockchain. Anyone can verify and audit transactions and smart contracts, boosting trust, loyalty, and accountability within the ecosystem.

• Financial Inclusion: This opens financial services to unbanked and underbanked populations who very well add value to the economy via services, products, or experiences. They can tokenize their assets both tangible and intangible, access loans, earn interest, and engage in multiple financial activities regardless of geography or socio-economic band.

• Trustless & non-custodial: No need for a chief and center entity with custody of funds. All users retain full autonomy of their assets and transactions occur directly between participants via smart contracts minimizing counterparty risks.

How DeFi differs from Trade Fi

“The banking system today still largely runs on legacy rails. Money doesn’t flow in real time. With the advent of stablecoins, money became programmable, settling in seconds around the clock, and providing transparency into transaction ledgers.”

– Peter Grosskopf, Unstoppable Finance’s co-founder, and CTO

Traditional finance organizations like commercial banks have long-winding processes and a track record of decent performance. They offer insurance and security mechanisms to ward off theft or derailment. They also require specific customer details and identification documents for participation.

On the other hand, DeFi has no nine-to-five or business working day thresholds or bureaucratic greenlighting processes. Without the involvement of banks, the DeFi market doesn’t sleep or slumber, transactions can happen 24/7 in real-time with no gatekeeping. Crypto can be stored on computers or wallets and remain accessible at all times. This primarily happens because of the technology that powers it.

The science behind DeFi

DeFi is built on blockchain technology, which was invented by more than one innovator. But the first DeFi apps appeared on top of the Ethereum chain invented by Vitalik Buterin. Since they have expanded to other networks that use smart contracts and automate transactions. Solana, Binance, Polygon, and Algorand, to name a few. They all use cryptographic techniques to ensure immutability, transparency, and consensus among participants.

Components of DeFi

1.Smart Contracts

As the backbone of DeFi, smart contracts are programmable codes that execute predefined actions when specific conditions are met.

2.DApps

Decentralized applications (dApps) are applications built on top of blockchain networks. They deploy smart contracts for multiple financial services like lending, payments, decentralized exchanges or marketplaces, or yield farming protocols.

3.Tokens & Token standards

Anything real-world or digital, tangible or intangible can be tokenized to create value in the economy. They can be transferred, traded, and stored just like traditional assets but with the added edge of being programmable and verifiable on the chain. Token standards are rules and protocols that adhere to respective blockchains (Ethereum-based ERC-20 for instance). This mechanism helps convert real-world assets like real estate, financial & insurance instruments, art, precious metals, carbon credits, company shares, or digital collectibles into digital tokens. They can be owned, fractionalized, and monetized, with better liquidity and broader access across demographics as compared to traditionally illiquid assets.

4.Liquidity Pools & Automated Market Makers

Liquidity pools are funds contributed by users for trading on decentralized exchanges (DEXs). These tokens can be redeemed allowing you to earn fees from trading activity. Intelligent market agents, also known as Automated Market Makers are the DeFi counterparts of traditional order books. Only, they leverage math formulas and algorithms to fix optimal asset prices and execute trades.

5.Oracles

Oracles provide external data to smart contracts and act as bridges between blockchain and real-world data allowing DeFi applications to access information like price feeds or weather data accurately for secure DeFi operations.

The science behind DeFi combines cryptography, distributed systems, game theory, and economics to create an open financial infrastructure. As a result, it revolutionizes TradeFi with increased accessibility, transparency, and efficiency.

Defi use cases and popular projects & platforms

“Defi means Decentralized lending and borrowing among other things. Each node in this Defi network is the new meaning of a bank. That means that instead of just a few big banks, there will be many banks embedded in every aspect of society. Every type of business and every type of organization will have a bank and every type of business and every type of organization will offer financial services.”

― Hendrith Vanlon Smith Jr, CEO of Mayflower-Plymouth

1. DEXs

DEXs allow users to trade cryptocurrencies directly with one another without the need for intermediaries. They provide liquidity pools where users can swap tokens, enabling efficient and transparent trading.

Uniswap is one of the most well-known DEXs. It operates on the Ethereum blockchain and utilizes an automated market maker (AMM) model. Users can trade ERC-20 tokens directly from their wallets, without the need for intermediaries.

SushiSwap is another popular DEX built on the Ethereum blockchain. It offers similar functionalities to Uniswap but introduces additional features like yield farming and staking, incentivizing liquidity providers with SUSHI tokens.

2.Decentralized Lending and Borrowing

DeFi lending platforms facilitate peer-to-peer lending and borrowing without the involvement of traditional banks. Users can lend their digital assets and earn interest or borrow assets by collateralizing their existing holdings.

Aave is a decentralized lending and borrowing protocol. It allows users to deposit their crypto assets into liquidity pools and earn interest, while also providing the ability to borrow against their deposited assets.

Compound is another prominent lending and borrowing protocol on Ethereum. Users can supply their assets to the protocol to earn interest or borrow assets against their collateral.

3.Stablecoins

Stablecoins are cryptocurrencies designed to maintain a stable value, often pegged to a specific asset like a fiat currency. They provide a reliable medium of exchange within the DeFi ecosystem and mitigate the volatility associated with other cryptocurrencies.

MakerDAO is a decentralized autonomous organization (DAO) that governs the creation and management of the DAI stablecoin. DAI is pegged to the value of the U.S. dollar and can be used for various DeFi activities.

Terra is a blockchain platform that offers stablecoins pegged to different fiat currencies. It aims to provide stability and ease of use for everyday transactions.

4.Yield Farming & Staking

Yield farming involves users providing liquidity to DeFi protocols in exchange for rewards, typically in the form of additional tokens. Staking involves users locking up their tokens to support network operations and earn rewards in return.

Yearn.finance is a yield farming platform that automates the process of maximizing yield on deposited assets. It leverages various DeFi protocols to optimize yield generation for users.

Synthetix is a decentralized synthetic asset issuance and trading platform. Users can stake their SNX tokens as collateral to mint synthetic assets that track the value of real-world assets, such as fiat currencies or commodities.

5.Insurance

DeFi insurance platforms offer decentralized insurance services, allowing users to protect their funds against smart contract failures, hacks, or other risks. These platforms use smart contracts to automate the insurance process and ensure transparency in claim settlements.

Nexus Mutual is a decentralized insurance protocol that allows users to purchase cover against smart contract failures and other risks. Users can buy coverage using the NXM token and participate in the governance of the protocol.

6.Decentralized Asset Management

Decentralized Asset Management in DeFi provides individuals with greater control over their investments and eliminates the need for traditional fund managers.

Yearn.finance offers decentralized asset management services through its suite of yield optimization strategies. Users can deposit their funds into various yield farming pools, and Yearn's smart contracts automatically allocate and optimize these funds across different DeFi protocols to maximize yield.

Melon Protocol is a decentralized asset management platform built on Ethereum. It enables users to create and manage their own investment funds, known as Melon funds. Fund managers can define investment strategies, set fees, and accept investments from other users. Melon Protocol also provides robust risk management features and transparent reporting.

These examples represent just a fraction of the diverse DeFi ecosystem. Each protocol offers unique features and functionalities, but all share the common goal of providing decentralized and permissionless financial services to users, allowing them to lend, borrow, trade, and participate in various financial activities without relying on intermediaries.

The Future of DeFi

“The Decentralization of Finance is really good for humanity and it’s ultimately a win for each and every one of us. Because now that we can circumvent banks, exchanges, and brokerage companies by using smart contracts on the blockchain… every person, every family, and every business will experience more liberty, more freedom, more opportunities, more abundance, more power, and more wealth. This makes way for more opportunities around financial wellness, permaculture investing, more effective crowdfunding, better ownership and equity arrangements, and more.”

― Hendrith Smith

Integration with TradeFi

“I think decentralized finance and traditional banking are going to experience a kind of hybridization within the next few decades; a blending together that results in something greater than the sum of its parts.”

― Hendrith Vanlon Smith Jr, CEO of Mayflower-Plymouth

Integration between DeFi and traditional finance (TradeFi) can bring several benefits and opportunities. Here are some ways they can integrate in terms of scale, interoperability, regulatory frameworks, and the evolution of use cases:

1.Scale:

DeFi can benefit from the scale of traditional finance by tapping into its large user base and financial infrastructure. Traditional financial institutions can explore incorporating DeFi protocols into their existing systems to offer decentralized financial services to a broader audience. This integration can help expand the reach and adoption of DeFi solutions.

2.Interoperability:

Interoperability between DeFi and TradeFi is crucial for seamless asset transfer and liquidity across different financial ecosystems. Projects like decentralized exchanges (DEXs) and liquidity protocols can work on integrating with traditional financial platforms to enable smooth token transfers and cross-platform trading. Interoperability standards and protocols, such as cross-chain bridges and common API frameworks, can facilitate this integration.

3.Regulatory Frameworks:

Establishing a regulatory framework that accommodates both DeFi and TradeFi is essential for responsible integration. Regulatory clarity can provide a stable environment for innovation while ensuring compliance with existing financial regulations. Collaboration between regulators, industry participants, and policymakers is necessary to address regulatory challenges and create frameworks that foster the growth of integrated DeFi and TradeFi solutions.

4.Evolution of Use Cases:

As DeFi and TradeFi integrate, new use cases can emerge. For example:

a. TradeFi participants can access DeFi liquidity pools for efficient and cost-effective financing, leveraging decentralized lending and borrowing protocols.

b. DeFi protocols can integrate with TradeFi infrastructure, allowing users to tokenize traditional assets such as stocks, commodities, or real estate, and trade them on DeFi platforms.

c. DeFi can provide programmable money and smart contract capabilities to TradeFi, automating and enhancing traditional financial processes like settlement, trade finance, and insurance.

Collaboration and partnerships between DeFi projects, traditional financial institutions, and regulatory bodies are vital to drive the integration of DeFi and TradeFi. This collaboration should focus on addressing technical, regulatory, and operational challenges while leveraging the strengths of both ecosystems to create innovative and responsible financial solutions.

Responsible DeFi participation for entrepreneurs

Participating in DeFi as an enterprise in a responsible manner involves several considerations. Here are some steps you can take:

1.Understand the Risks:

Familiarize yourself with the risks associated with DeFi, including smart contract vulnerabilities, regulatory uncertainties, and market volatility. Conduct a thorough risk assessment and ensure your enterprise has the necessary risk management measures in place.

2.Regulatory Compliance:

Stay informed about the regulatory landscape surrounding DeFi in your jurisdiction. Understand the legal and compliance requirements related to participating in DeFi and ensure your enterprise complies with relevant regulations, including Know Your Customer (KYC) and Anti-Money Laundering (AML) policies.

3.Conduct Due Diligence:

Perform thorough due diligence on DeFi protocols, projects, and platforms before engaging with them. Assess factors such as project team credibility, code audits, security practices, and transparency. Look for projects that prioritize security, have a track record of responsible behavior, and align with your enterprise's values.

4.Consider Audited and Established Projects:

Consider participating in DeFi projects that have undergone third-party security audits from reputable firms. These audits help identify potential vulnerabilities and provide assurance of a project's security and reliability. Established projects with a solid track record may also be more reliable options.

5.Engage in Responsible Governance:

If participating in decentralized autonomous organizations (DAOs), actively engage in governance processes. Vote responsibly, participate in discussions, and consider the long-term sustainability and responsible practices of the projects you support. Encourage transparency and accountability within the DeFi ecosystem.

6.Implement Robust Security Measures:

Protect your enterprise's digital assets by implementing robust security measures. Use secure wallets, multi-factor authentication, and hardware security devices to safeguard your funds. Regularly update software and follow best practices for cybersecurity to minimize the risk of hacks or theft.

7.Educate Employees:

Provide education and training to employees about DeFi, its risks, and responsible practices. Encourage them to exercise caution and make informed decisions when interacting with DeFi platforms. Promote responsible behavior and ensure employees understand the importance of safeguarding assets and adhering to compliance requirements.

8.Monitor and Adapt:

Continuously monitor the DeFi ecosystem, regulatory changes, and emerging risks. Stay updated on best practices and industry trends. Be prepared to adapt your participation strategies as the DeFi landscape evolves to ensure ongoing responsible engagement.

Defi in a nutshell

“Decentralized finance is an unbundling of traditional finance, DeFi takes the key elements of the work done by banks, exchanges, and insurers today—like lending, borrowing, and trading—and puts it in the hands of regular people.”

Rafael Cosman, CEO and co-founder of TrustToken.

2023 started off heading toward recession, showed a strong, bullish trend, especially in the NFT market. On-chain metrics like Total Lcked Value (TLV) and Unique Active Wallets (UAW).

→ The ecosystem as of May 2023 saw a 4.3% decrease slipping to $79.16 billion in stark contrast to the projected numbers

→ Ethereum maintains dominance with a 66.85% market share as other blockchains compete for the spotlight. #Fantom has the hardest hit with a 37% decrease in TVL, reducing to $308 million. Zk Rollups, Layer 2 solutions show promising growth with significant TVL, ranking only behind Abitrium and Optimism.

→ The increase in UAWs, in the aftermath of the fallout of Silicon Valley Bank and First Bank shows its growing popularity for alternative solutions that are autonomous, secure, and flexible

→ For the first time ever, Unique Active Wallets (UAW) are all DeFi dApps, Stargate Finance leads with 1.51 million UAWs with a massive 480% increase since the previous month

On-chain metrics have shown significant growth and activity indicating a thriving and promising next quarter across multiple use cases.