The Rise of Decentralized Finance (DeFi) and Why it Matters

DeFi is short for “Decentralized Finance”, a generalized umbrella term used to describe a variety of cryptocurrency and blockchain-based financial applications geared towards disrupting legacy financial institutions.⁵ DeFi is not reliant on central financial intermediaries such as brokerages, exchanges, or banks to offer users access to traditional financial instruments, and instead utilizes smart contract-based applications that are built on top of existing blockchain-based platforms. A smart contract is enforced via lines of code, automatically executing transactions if certain conditions are met, nullifying the need for any brokers or financial intermediaries.⁵ The main benefit of a smart contract is that it facilitates trust (a key facet of any financial transaction) between individuals who may not ever even know or get the chance to know each other. In other words, they render the system “trustless”, where you don’t have to trust the individual you are transacting with because both parties are beholden to the logic dictated within the code. This design mechanism is the foundation beneath the various decentralized asset management tools, crypto derivatives, yield aggregation platforms, decentralized crypto exchanges, and many other applications within the DeFi ecosystem.

There are several large scalable platforms currently available that enable smart-contract-based applications, with new projects releasing around the clock.

A few notable platforms are Solana, Polygon, and, currently the most popular platform, Ethereum. Ethereum already has 221 official projects listed in the DeFi space, including a wide range of utilities. A wide range of DeFi protocols utilize their unique token that can be stored in a pool. Often individuals contribute their cryptocurrency tokens to these pools to provide liquidity for the market, thus earning the contributor’s interest on their stored coin. Currently, $88.9 billion is locked in DeFi smart contracts for these purposes.⁴ Below we’ve listed a few of the top DeFi protocols by share of value locked:

Aave: Total value locked in the ecosystem: $15.52 billion

An open-source non-custodial protocol on Ethereum for decentralized lending and borrowing.  Aave offers flash loans: trustless, uncollateralized loans where borrowing and repayment must occur in the same transaction.⁴ Aave is the #1 DeFi Protocol by share of value.

InstaDapp: Total value locked in the ecosystem: $13.02 billion.

A smart wallet for managing assets, allowing users to lend, save or migrate debts between various DeFi Protocols such as AAVE and Compound.⁴

UniSwap: Total value locked in the ecosystem: $6.34 billion.

A fully decentralized on-chain protocol for token exchange on Ethereum that uses liquidity pools instead of order books. Anyone can create a market (ie., liquidity pool).⁴

Synthetix: Total value locked in the ecosystem: $1.79 billion.

a decentralized platform on Ethereum for the creation of on-chain synthetic assets that track the value of real-world assets. The Synthetix platform supports over 30 Synths representing fiat currencies, commodities (e.g., gold), and crypto assets. Stocks, indices, and other derivatives.⁴

As the DeFi space matures, many institutional investors envision the day when all assets, equities, and financial products exist in some form of cryptocurrency.¹ Philip Gradwell, Chief Economist at Chainalysis, the blockchain data platform says, “What decentralized finance shows us is that financial instruments can move entirely to the blockchain”. Stocks are a likely contender to be digitized first and we have already seen Apple and Tesla have crypto tokens circulating that mirror their share price.¹ Although borrowing and lending are the most common use cases, developers are only limited by their imagination. Alongside the aforementioned scenarios, the emerging NFT space is also predicated on DeFi applications and developers are even writing scripts for fair lotteries.¹ As the space evolves and protocols are brought in line with institutional needs, projects geared specifically toward institutional investors will be adopted which could be the last nail in the coffin for traditional financial institutions, and the birth of a new world of finance existing on the blockchain. Though, before this happens, the adolescent nature of the space riled with scam projects and dishonest actors must mature. The tradeoff for being on the ground floor of this technology is exposure to high levels of risk if adequate research is not done. Even if adequate research has been conducted, the risk of hacks, given that this space is strictly digital, is always prevalent. DeFi hacks have made up 76% of major hack volume in the crypto space this year according to  CipherTrace’s “Cryptocurrency Crime and Anti-Money Laundering Report“. That works out at some $361 million, 2.7 times more than in 2020.²