You may have come across the term ‘DeFi’ while exploring the world of crypto. In case it’s left you feeling puzzled, let us lay it down for you in simple terms.
DeFi stands for Decentralised Finance and describes the bigger picture behind crypto - an entire financial system (which cryptocurrencies are a part of) built on blockchain technology. Sometimes referred to as the Open Finance movement, the idea is to give everyone complete control over their own assets and make financial services available to the 1.7 billion people around the world who lack access to them.
This is achievable through the creation of a new ecosystem of financial applications - built upon open-source software and decentralised networks - which eliminates the need for any central, controlling authority or profit-seeking middleman.
Instead of monetary transactions such as trading or borrowing being carried out via an intermediary (like an exchange or bank), they take place directly between parties, through an automatic process. This is possible thanks to programmable, self-executing agreements encoded on the blockchain, known as smart contracts.
Ethereum is probably the best known, fully functioning DeFi network. The scalable open-source software platform enables anyone to create decentralised apps (‘dApps’) on it, using smart contracts.
So, how will DeFi help bank the unbanked? It could massively reduce the costs involved in foreign remittance, for one. Without the need for certain intermediaries, over 50% could be slashed off the often prohibitively high fees incurred for sending money abroad. It could also become possible to take out loans quickly and easily, without the need for a credit history.
Recent research by the World Bank shows that over two-thirds of the world’s unbanked now own mobile phones, which could give them instant access to DeFi platforms - if they were widely known.
It doesn’t stop at banking solutions, either. In years to come, the DeFi ecosystem could encompass every aspect of finance - not just transactions made with digital currencies, but digital assets of any kind, such as commodities or even real estate. It could well be the enabler of a token economy.
As with any new transformative movement, there are potential problems which need addressing before it can take off on a large scale. One concern is that public blockchains may be unable to handle the volume of transactions that would be required were the masses to get on board.
Considering also that current DeFi organisations exist independently of each other in a fragmented market, and each country has wildly different regulations and attitudes towards blockchain and crypto - there’s a long way to go before DeFi reaches all corners of the globe.
When decentralised finance is ready for mainstream adoption, though, it could do a great deal to address financial inclusion by putting the power into the hands of the individual and being open to all.