A new movement has been taking the crypto world by storm over the last two years. It’s called Decentralised Finance, or DeFi for short, and it defines the popular notion that crypto entrepreneurs can recreate traditional financial services, such as lending, borrowing and insurance, outside the traditionally centralised architecture of traditional financial services.
Built on blockchain, DeFi exists outside the control of governments and corporations. With fresh allegations of misconduct by centrally controlled banks and financial services companies occurring on an almost daily basis, the argument for decentralised applications is becoming increasingly relevant. Before it was commonly known as decentralised finance, the idea of DeFi was often called “open finance.”
Most decentralised applications (dapps) are built on top of Ethereum, the world’s second-largest crypto blockchain, and this one of the main reasons that many analysts expect the price of Ether to skyrocket in 2021.
Ethereum is different to Bitcoin in that it allows people to build other types of apps that go beyond the simple transactions that Bitcoin facilitates, using something called smart contracts. Smart contracts automatically execute transactions only when certain criteria are met, which offers much more flexibility than traditional one-time hit-and-send transactions.
For example, let’s say you want to send money to your daughter on Thursday, but only if their exam scores exceed a minimum grade based on the results on the accreditor’s website. These kinds of rules can be written into a smart contract. With these smart contracts at its core, thousands of DeFi applications now operate on Ethereum.
Examples of Decentralised Applications (dapps)
- Decentralised Exchanges, or dexs, such as Uniswap. These are entirely peer-to-peer exchanges that connect users directly to each other so they can exchange ethereum-based DeFi tokens with one another without trusting an intermediary with their money or assets.
- Lending platforms are another popular form of DeFi, which connects borrowers to lenders of cryptocurrencies.
- DeFi lending is collateral-based, meaning in order to take out a loan, a user needs to put up collateral – often ether, the token that powers Ethereum. This increases the demand for Ethereum as it becomes critical to borrowing and lending in DeFi. Another benefit of these services is that users don’t need to share their identity and don’t have any associated credit scores which could harm their loans.
- Liquidity mining was without a doubt the biggest craze to grip blockchain in 2020. Liquidity mining, also known as yield farming, is a rewards scheme that lets crypto holders lock their tokens in decentralised networks in return for earnings. This effectively bootstraps the project, providing the necessary liquidity required for it to function.
Why the DeFi Craze?
DeFi has flourished because of the stark contrast it presents as compared to traditional financial services. For example, in traditional lending, companies are legally required to know and record your identity, including personal details such as a person’s name and social security details, as well as credit history that allows the institutions to assess a person’s ability to finance the debt. In DeFi, there are no such requirements – it’s all about preserving privacy, and guaranteeing all transactions through the use of smart contracts. For some services, there is also often a high emphasis placed on trust.
Paradoxically, a second reason for the surge of DeFi is that mainstream players are getting involved, with high-street financial institutions now seeking ways to participate. Up to 75 of the world’s leading banks are now trialling some form of blockchain technology in order to speed up rate payments. These institutions include JP Morgan, ANZ and Royal Bank of Canada.
Major asset management funds are starting to take DeFi seriously as well. Most prominent is Grayscale, the world’s largest crypto investment fund. It currently manages over US$5.2 billion of crypto assets, including US$4.4 billion of bitcoin.
The pandemic has also become a major growth factor for DeFi. It has driven global interest rates lower, and in the case of some jurisdictions such as the eurozone, interest rates are now in negative territory, while other territories such as the US and UK could potentially follow.
Ether To Rise In 2021?
Only three months into 2021, and DeFi has set records with the total value locked in DeFi assets crossing the $25 billion mark for the first time. With the appetite for decentralised finance growing exponentially, and because the DeFi ecosystem lives and breathes on Ethereum, many analysts are seeing 2021 as the year to invest in the world’s most important smart-contracts token, Ether.
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