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Decentralized Finance (DeFi) has engulfed the financial world. It is seeping into global economies due to its core functionality and how it is power-driven and based on blockchain technology a decentralized, distributed, and open digital ledger that is used to track transactions across several computers in a way that prevents changes to the record from being made in retrospect without also changing all following blocks and obtaining network consensus. Below, we will delve deeper into the current state of DeFi and discuss how it can potentially disrupt finance systems in the traditional sector. Furthermore, we will explore and highlight the challenges of DeFi and what needs to be done to overcome these challenges and gain widespread adoption. Join us as we uncover the future of decentralized finance.

DeFi, which stands for decentralized finance, is a catch-all name for apps and projects in the public blockchain environment aimed at upending the established financial sector. DeFi refers to financial apps created with smart contracts and based on blockchain technology. Smart contracts are automated, legally binding contracts that can be executed without the assistance of a third party. Anyone with an internet connection can use them to conduct financial transactions and carry out various other tasks.

DeFi comprises peer-to-peer protocols and apps created on decentralized blockchain networks without access rights. Financial tools can be easily lent, borrowed, or traded using decentralized apps (dApps). The Ethereum network is used to build the majority of DeFi apps today. Still, several new open networks are gaining popularity because of their greater speed, scalability, security, and affordability.

Looking at history, financial systems in the traditional sector have been for the lifecycle of money, leading to various fiat currencies emerging and having those currencies led and guarded by central authorities (governments) and other intermediaries. In all honesty, it is important that we express the truth and reality of what we have experienced and continue to experience with centralized currencies that are not only politically affiliated but make the richer even richer and expand the already large gap between the rich and poor as the poor are becoming even poorer.

Looking at global economies today, many people across different financial classes struggle. Furthermore, due to the structures that exist across different sectors and institutions and the way things have generally been set up for years, those across different financial classes, specifically the middle and lower classes, are struggling, leading to an ongoing cycle of people being either not making enough, drowning in debts, being on the verge of poverty and others struggling to make it out of poverty, while the richer become even richer.

DeFi was designed as an alternative and a solution that would help to minimize the need for reliance on and faith in a centralized authority while creating a financial system that is accessible to everyone.

It is important to note that DeFi is a relatively new but growing concept. Some claim that the beginning of DeFi occurred in 2009 with the introduction of Bitcoin, the first peer-to-peer (p2p) digital asset constructed on top of the blockchain network, making it feasible to foresee a change in the established financial sector. Blockchain technology has become a crucial next step in decentralizing antiquated financial institutions. It was all made feasible by introducing Ethereum in 2015 and, more precisely, smart contracts. The Ethereum network is a second-generation blockchain that fully exploits this technologys promise in the financial sector. It supported companies and organizations in creating and implementing the projects that made up the DeFi ecosystem.

A decentralized finance and digital asset educational specialist at Bitai Method mentions that DeFi has opened up numerous possibilities for building a reliable and open financial system that is not under the authority of a single institution. In 2017, initiatives turned a corner and expanded beyond simple money transfers. DeFi has since developed into a fully functional ecosystem with functional applications and protocols that benefit millions. As of April 2022, DeFi ecosystems contained assets worth approximately $239 billion, making it one of the public blockchain spaces fastest-growing subsectors. In 2022, the market for decentralized finance was estimated to be worth USD 13.61 billion. From 2023 to 2030, it is anticipated to increase at a CAGR of 46.0%.

As seen above, it is evident that DeFi has had quite a growth in traction over the past few years that has greatly influenced and revolutionized traditional financial markets. This is evident through the numerous DeFi platforms that offer permissionless access to financial services, inherently transforming how we deal with money, especially regarding transactions, lending, investments, and borrowing.

As mentioned above, one of the core foundations and pillars of DeFi is the concept of smart contracts blockchain-based programs that function and execute when specific criteria are met. They are often used to automate the implementation of an agreement so that all parties can be sure of the conclusion immediately. In more straightforward and more practical terms, smart contracts as legally binding contracts help to eliminate the need for a central authority and intermediaries, including banks and brokers, further eliminating any delay, rejection, or bias from central authorities and middlemen. Smart contracts further make finance access more accessible and less complex. All of the aforementioned provide users with greater control and autonomy over their assets and reduce reliance on central authorities this further promotes and perpetuates greater financial autonomy.

For obvious reasons, DeFi apps are booming and seeping into different industries. Weve got decentralized exchanges (DEXs) that let people trade directly with each other without the need for a middleman. Its all about liquidity and giving users many choices regarding trading tokens. Then, there are lending and borrowing protocols that let users lend out their stuff to earn interest or borrow assets by using what they already have as collateral. And lastly, there is yield farming! Which is all about making the most of your returns using different DeFi platforms, usually by providing liquidity or staking your tokens.

DeFi poses a threat as it has enormous potential to disrupt and dismantle global financial systems and economies in multiple ways; this includes the significant threat of potentially replacing banks. Looking at the record of the crypto-verse and the technology that supports it, we can assume that as a wealth vault, a medium of exchange, and a unit of account, DeFi might easily replace cash. By offering quicker transactions, higher security, reduced fees, and smart contracts, decentralized blockchain-based systems can take the position of banks. Through DeFi, we may lend and borrow money, raise money for initiatives, and transfer money. Those above are just the beginning, too, as many investors and enthusiasts believe that traditional banking and finance might soon be replaced by a decentralized economy that is more effective and scalable.

One of the biggest advantages of DeFi is that it gives unbanked or underbanked people a chance to access financial services without relying on traditional gatekeepers. This inclusivity has the potential to bridge the global wealth gap and help people become more financially independent.

Unfortunately, traditional financial systems often exclude people who dont have easy access to banking services due to high transaction fees, lack of identification, or geographic limitations. But with DeFi, anyone with an internet connection can participate in the global financial ecosystem. This is especially impactful in developing countries where traditional banking infrastructure is limited.

Another great thing about DeFi is that it can improve transparency and security in financial transactions. Using blockchains immutability, DeFi platforms can ensure tamper-proof records and real-time auditing. Traditional financial systems are often opaque and centralized, which can lead to fraud and manipulation. With DeFi, participants can trust that their transactions are secure and that theres less need for intermediaries.

Finally, DeFi enables decentralized governance models where stakeholders have a say in decision-making processes. This shift towards community-driven governance challenges the centralized control of traditional financial institutions and promotes a more democratic and equitable system. With voting mechanisms and decentralized autonomous organizations (DAOs), participants can actively shape the future of DeFi platforms and ensure that they align with community interests.

Although DeFi has a promising future, it is imperative to remember that it is a relatively new and growing concept with numerous hurdles and challenges that must be addressed throughout the development process. One of the main concerns we can note is scalability. Although DeFi is scalable, it also has shortcomings, specifically regarding network congestion and high transaction fees, which have become prevalent issues resulting from DeFi gaining momentum and growing in popularity.

To delve deeper into this, the Ethereum Network, which holds many DeFi applications, must work on scalability limitations. However, solutions have been introduced in the form of blockchain interoperability and Layer 2 protocols Blockchain Layer 2 solutions are protocols that run on top of a Layer 1 blockchain (such as Bitcoin or Ethereum) to enhance the underlying blockchains scalability, privacy, and other properties. The most popular options are state channels, sidechains, optimistic Rollups, and zero knowledge Rollups. All those mentioned above are actively being explored to address the challenges and ensure a functional and seamless user experience.

Additionally, regulatory frameworks are another aspect that poses a significant hurdle to DeFis widespread acceptance and adoption. As it stands, no global regulatory framework or policy governs or regulates the digital asset industry. The regulation of cryptocurrencies and decentralized systems is a tough issue for governments worldwide, and it has become more difficult to strike a balance between investor protection and innovation. To create a regulatory environment that encourages innovation while defending the interests of users, cooperation between industry participants, lawmakers, and regulators is essential.

Moreover, the user experience of DeFi platforms can be quite complex and hard to learn, especially for those just learning about digital currencies and everything related to the sector. Therefore, this complexity and steep learning curve create limited accessibility for newcomers.

For those who need to become more familiar with blockchain technology, the difficulties of connecting with wallets, managing private keys, and comprehending the subtleties of many protocols can be overwhelming. To promote widespread adoption, user interfaces can be made simpler, educational resources can be improved, and smooth onboarding procedures can be offered.

DeFi is transforming finance, enhancing transparency, inclusivity, and democracy. It has the potential to replace traditional systems, empowering individuals, strengthening security, and reinventing governance. While challenges exist, solutions are emerging. Collaboration among DeFi projects, industry players, and regulators is crucial for safe and accessible DeFi. Intuitive user experiences and educational resources can broaden access. Embracing innovation and overcoming hurdles will reshape finance, unlocking possibilities globally. Staying informed, adapting to change, and advocating for an open and accessible financial system are vital for the future.

Byline: Hannah Parker

Excerpt from:

The Future of Decentralized Finance - The Bay Citizen