The technological prowess of blockchain coupled with the increasing popularity of cryptocurrencies have led to a global open finance movement in the form of the decentralized finance (DeFi) framework. The rise of DeFi has been nothing short of astounding. In August 2019, the value of cryptocurrencies locked in the DeFi ecosystem stood at about US$500 million. Fast forward six months later to February 2020 and the amount has doubled to US$1 billion with MakerDAO’s DAI stablecoin constituting the bulk of the billion dollars worth of locked-in cryptocurrencies making up for 60% of the total volume.
A notable factor which has served as a precursor to the astronomical growth of the DeFi ecosystem may lie in the systemic weaknesses plaguing the conventional financial system which has given rise to a host of operational risks including those relating to fraudulent transactions, privacy breaches and bank runs. The decentralized mode of operations under the DeFi ecosystem would go a long way towards addressing these operational risks.
On a more subtle note, the rise of DeFi may also be due to its immense potential in rectifying the shortcomings of the conventional financial system which has left about one in five of the global population of adults (i.e. 22%) to be unbanked i.e. to be without any access to banking and financial services. As for those who are banked, DeFi also has something to offer to them in the form of a more flexible user experience whereby this may prove to be a boon for the estimated 66% of bank customers who are lacking in terms of their understanding of basic financial concepts. Given all these impressive facts and figures about the DeFi ecosystem, one may wonder what precisely are the features and functions of the ecosystem?
In essence, the DeFi ecosystem sets out to offer a more viable alternative to the conventional financial system in the form of a decentralized financial system constructed on top of public blockchain networks, such as those of Bitcoin and Ethereum. In terms of the basic structure of its operational framework, DeFi entails the development and operation of financial decentralized applications (DApps) on top of public blockchain networks. To put it simply, DeFi is a movement which aims to incorporate the decentralization ideals of blockchain as part of the operations of the financial landscape.
From a macro-social perspective, the DeFi movement offers a possible remedy to the rising inequality in wealth distribution among the global population which is due in no small part to the centralized nature of the conventional financial system. Leveraging the digital technological revolution in particular the rising levels of internet connectivity in developing economies and the proliferation of smartphone use among the global population, DeFi is set to trigger a paradigmatic shift in the financial sector by combining the twin pillars of blockchain and cryptocurrencies to take the idea of digital banking to a whole new level.
The fundamental principle of DeFi is that it strives to adopt the synergistic deployment of blockchain and cryptocurrencies to spearhead the global digital banking revolution through a three-pronged approach encompassing (1) the promotion of financial inclusivity (2) the lowering of financial transaction costs and (3) adopting a privacy and security-centric approach. In terms of promoting financial inclusivity, DeFi aims to widen global access to financial services by removing the barriers to entry in the form of status, wealth and location obstacles whereas to lower financial transaction costs, DeFi advocates embarking on the disintermediation process to pave the way for affordable cross-border payment transactions. As for its privacy and security-centric approach, DeFi would leverage the immutable and transparent nature of blockchain to facilitate the making of censorship-resistant transactions.
On the commercial front, the DeFi ecosystem has played host to several notable use cases which operations cover the areas of crypto lending and borrowing as well as derivatives and asset management. With regard to crypto lending and borrowing, MakerDAO is certainly an industry leader whose name will ring a bell with most crypto users. Operating using a pegged stablecoin model, MakerDAO’s platform allows Ether (ETH) holders to use their tokens as collateral in order to borrow US Dollar (USD-pegged DAI stablecoins by placing their ETH tokens in reserve under a Collateralized Debt Position (CDP).
In the area of crypto derivatives, Universal Market Access (UMA) stands out with its decentralized financial contracts platform which open-source protocol allows users to create their own customized smart contracts to hedge the risks exposure levels of their crypto investments. As for crypto asset management, Abra’s crypto wallet allows users to invest in cryptocurrencies in a systematic and secure manner through its portfolio management facilities provided through its mobile application. As an additional layer of security, Abra’s crypto-collateralized stablecoin model ensures that its users are protected from market price fluctuations.
With Singapore which is one of the world’s leading financial hub choosing to ride on the global digital banking wave with virtual banks slated to commence operations in the city-state by mid-2021, the DeFi ecosystem looks set to forge ahead on its path to perhaps outperform
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