DeFi Series 1: The Problem DeFi is Trying to Solve
DeFi is the acronym for Decentralised Finance. Although the acronym is short and easy to spread, the term DeFi belies the original meaning — it is a new financial system that is entirely decentralised.
DeFi is still in its infancy, and in 2021 it will total just under $10 billion, compared to the trillions of dollars of assets held by the traditional financial services system. However, DeFi’s growth is not only extremely rapid in terms of asset size, but also in terms of developer growth, with an average of 500 new developers joining DeFi every month since June 2020 (figures quoted from ElectricCapital’s annual report).
So why has DeFi emerged and what problems can DeFi solve?
The problems of the traditional financial system
Before discussing the problems that DeFi can solve, let’s clarify what problems have arisen in traditional finance to date, and then correspond to DeFi.
Over the centuries, people have grown accustomed to borrowing and lending through traditional banking institutions and to completing financial transactions through intermediaries under conditions where the central bank controls the money supply. These processes have created the following problems: centralised control, narrow channels, inefficiency, fragmentation and opacity.
Centralised control: In a centralised banking system, the various layers form a unified entity that controls interest rates and influences inflation, which for most ordinary people takes on the risks associated with centralised institutions without ever enjoying the benefits of taking risks.
Narrow access: to this day, there are still 1.7 billion people in the world who have never used banking services, and these people find it difficult to obtain loans from banks and to survive in the world of internet commerce. Not only that, but in many countries where banking services are available, the barriers to lending and financing remain high and many individuals and projects that need loans are very difficult to access.
Inefficiencies: The inefficiencies of the traditional financial system are numerous, especially in the Internet age, and have reached intolerable levels, such as the high and slow cost of transferring funds, the need to pay direct and indirect intermediary fees, the lack of security, the impossibility of microtransactions, and the fact that many users are not expecting the inconveniences that abound in real-life scenarios.
Fragmentation: Although the modern financial system is gradually forming a unified whole, the process of transferring funds from one bank to another is not only time-consuming but also very complex. Consumers and businesses are connected in an unconnected context, and this complexity increases exponentially, so that often the whole project is delayed or even fails because of small intermediaries.
Opaque: The traditional financial system is very opaque and no one knows the exact financial health of the banks, which makes it easy to lose confidence in them at certain critical times, as evidenced by the many bank runs throughout history. Despite the fact that there is now oversight by international banks and central banks, these institutions are still centralised and there is still a black box, and it is only a matter of time before a black box occurs with a run.
The problem DeFi can solve
DeFi, as a proven effective way to lead the new financial system, is attempting to create and combine open source financial infrastructure modules to build more complex financial products, thus using blockchain technology to provide and deliver the value of the most effective finance to a wider range of people and users, while solving several of the problems of the traditional financial system mentioned above.
Solving centralised control: DeFi subverts centralised control through an open, transparent and tamper-evident contractual protocol. Based on the open source spirit of the blockchain and the public nature of smart contracts, flaws in DeFi projects can also be easily identified and flawed projects can be easily replicated and improved by means of forks. As a result, the open transparency and security that comes with a decentralised approach will incubate powerful protocols and ultimately become a trusted financial infrastructure for users worldwide.
Solving narrow channels: As smart contract platforms appear in more and more contexts and the user experience becomes smoother, reaching more and more users, more people will have access to financial services directly from DeFi.
Solving inefficiencies: DeFi is able to leverage dApps to enable high volume transactions, and also by creating reusable smart contracts, users will be able to perform specific financial operations regardless of the size of the transaction. For Ethernet-based DeFi in particular, the contracts can be used by anyone for a transaction fee, and once deployed they are continuously available, with virtually zero maintenance overhead afterwards.
Solving fragmentation: the various features of DeFi are like building blocks that can easily be combined into new DeFi products, and innovation will abound. Once the infrastructure is in place, for example, a certain asset is created, protocols for borrowing and lending can be used, and furthermore, leverage can be used on top of the borrowed asset. As new platforms continue to emerge, this interoperability will manifest itself in more and more directions, allowing for more complex and multi-path financial needs to be fulfilled by users. The term DeFi Lego blocks is now commonly used as a metaphor for combining existing protocols into new ones.
Solving opacity: DeFi solves this problem very cleverly through the openness and contractual nature of contractual agreements. The transparent nature of smart contracts significantly lowers the threshold of trust, allowing everyone to read the contract, negotiate the terms, dispel misunderstandings and ultimately agree on them. Such clarity and transparency significantly reduces regulatory barriers, allowing all volumes of participants to trade and meet needs with confidence.
Like the internet, DeFi will make financial services cheaper, faster, safer and also tailor-made. Just like YouTube and Twitter, it is not only free, but it is also very easy for users to create/watch videos/post opinions on it, hence its exponential growth in content. Along the same lines, if DeFi allows anyone to create and use anything at near-zero cost, what changes could DeFi bring to financial products?The answer awaits to be written in the future.
About Bitbyte
Bitbyte.finance provides SAAS services for developers in the Web3 space, including Defi&NFT applications, Swap and mining pools, and community traffic services. Bitbyte is committed to helping developers quickly build their own Defi finance ecosystem and lower the threshold for traditional users to migrate to decentralized finance, creating a secure, convenient, reliable and reliable and their own decentralized platform.
