Blockchain driven finance helps unbanked people participate in the economy.
The great crypto rise couldn’t have been possible if the Defi push of 2020 hadn’t compelled fintech enterprises to steer their preferences. That’s the purest form of decentralized finance that the bitcoin whitepaper hailed a decade ago. As a result, numerous investors and financial service providers who were stuck to the traditional wallet products woke up to the potential of the new age money. In fact, the DeFi market cap rose by 2000 per cent in 2020 in the same year.
DeFi or decentralized finance is a direct offshoot of Blockchain driven finance that aims to revamp the structure and modalities of fiat finance (money in circulation such as paper money or coins). It does not rely on central financial institutions such as brokerages, exchanges or banks to offer services. Instead, it uses smart contracts on blockchains to deliver consumer services with finesse. DeFi has promising applications in the best interest of the institutions as well as the consumers.
DeFi services are essentially a set of protocols, each designed to do specific tasks with the goal of bringing buyer and supplier together without any middlemen. All technology used here is open source and thus, transparent. Anyone with a mobile phone and internet service can use a DeFi.
DeFi caters to three large functions that cannot be carried out by fiat finance. DeFi helps in creating monetary banking services (for example, issuance of stable coins); providing peer to peer or pooled lending and borrowing platforms; and enabling advanced financial instruments such as decentralized exchanges (DEX), tokenisation platforms, derivatives and predictions market. All banking services such as lending, borrowing, staking and investing can be made DeFi compliant as it promises a full-fledged capital market.
Compound, launched in 2020 is an example of DeFi service that caused a stir when it created a Compound token (COMP) along with the service. Users who invested in various Compound services would earn COMP tokens as a reward, earning decent returns on their assets. Other DeFi services adopted this reward system as a way to attract users. Compound has since grown to over $9.3 billion in assets across 12 countries.
How Will DeFi Resolve The Issues Of Fiat Finance?
Centralized finance, although reliable, is not a democratic system. Central institutions raise the barrier to financial services by requiring proof of identity and access to a bank account. But there are many in the world who cannot meet those requirements. A 2018 report by the World Bank estimated that there are 1.7 billion people who are unbanked. Yet two thirds of them have access to a mobile phone. DeFi and the delivery of digital financial services allow such unbanked people to participate in the economy. For example, a farmer with a smartphone could buy and sell goods using a non-depreciating currency like Bitcoin and earn interest on the money he saves using a DeFi service. He would not have to show a birth certificate (he doesn’t have one) to open a checking account at a local bank.
Small to medium enterprises (SMEs) have also been benefitted. Today's financial institutions typically set a high bar for risk-return on their investments, making it very difficult for SMEs to obtain loans if needed to expand their business. DeFi makes it possible for SMEs, particularly those in emerging economies, to access credit, exchange and investment services without the restrictions of the traditional financial system.
DeFi could emerge as one of the most transformational technological changes in global economy, not only because of the breadth of impact on the global financial system but also due to the impact it can have on billions of people who fail to participate in the economy, thus financially empowering them.
Vikram R Singh is the founder of Antier Solutions.
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