With the creation of cryptocurrencies and the underlying technologies that come with them, one of the biggest developments and most feared by the financial sector is the rise of Decentralised Finance, commonly known as “DeFi.”
DeFi is a broad term for alternative financial systems and services which are built on top of blockchain technology. This new digital universe is modelled toward building a new, internet-native financial system using blockchain technology to replace traditional [archaic] financial systems.
In layman’s terms, DeFi is financial services that are completely internet-based, uses blockchain as its backbone and can be implemented and executed in real-time without any middlemen. This provides users with greater efficiency and lowers costs to transact.
Defi systems follow specific protocols (a set of rules for transacting and regulating token supply) executed via smart contracts. DeFi competes with existing financial services by offering global access and exploiting the limitations of traditional banking systems. For instance, cross-border payments take anywhere between 2 to 3 days to settle, whereas, in the DeFi environment, settlement can occur within minutes. DeFi protocols compete across multiple financial sectors including lending, insurance, and exchange.
One fundamental difference between traditional finance and DeFi is that traditional finance is largely dependent on human resources to process and approve decisions and perform tasks (for example, the approval of a home loan) whereas within the DeFi ecosystem all activities are fully automated through smart contracts.
AAVE is a prime example of an automated DeFi protocol. AAVE allows customers to deposit their cryptocurrency as collateral when applying for a loan. The process of applying and receiving approval/rejection is all done online and takes a few minutes. To date, AAVE has received deposits of more than USD 200 billion in cryptocurrency.
The efficiencies within the DeFi environment are enhanced given that there is no need to engage with a human gatekeeper. The obvious reason for the rapid growth of DeFi is centred around the competitive advantages it has over traditional financial systems, a few examples can be summarised below:
|24 hours a day
|365 days a year
|Up to 3 days
|Moderate to high
|Anywhere with an internet connection
|Limited to the financial institutions’ capabilities
|Longer than 24 hours
|No permission access DeFi protocols
|Long-drawn out applications processes, including FICA, credit approvals etc
Although DeFi offers ordinary people the ability to transact globally, 24/7, 365 days a year, the majority of consumers are years away from adopting this technology in their everyday life. However, given the efficiencies and low transaction costs, it’s highly likely that cryptocurrencies linked to protocols will continue to appreciate over time, the question is which protocols will be the next Goldman Sachs of the DeFi world.
Jonty Sacks – Partner at Jaltech
Jaltech offers investors exposure to a basket of cryptocurrencies which is selected and managed by a team of cryptocurrency experts.