A cryptocurrency can be defined as a digital currency which is independent of any central maintenance authority (e.g bank or government), and serves as a medium of exchange over a computer network. This definition of cryptocurrency reflects a major inspiration for their creation - a public, non centralized means of exchange. The idea of such a means of exchange was conceived in the 1980s and gradually became important to people after many financial crisis and malpractices from centralized financial institutions like banks. This was the case for Bitcoin which was released after a major financial crisis in 2008, running on the blockchain network as the worlds first decentralized cryptocurrency.
Many other cryptocurrencies (e.g Litecoin, Etherium etc.) followed suite in the subsequent years but these decentralized digital currencies were falling short of the main purpose for their creation – serve as an accepted alternative means of exchange to the currencies issued by banks and governments. One of the reasons for this failure was the fact that each cryptocurrency was only useful within its blockchain. Also, people were either ignorant or distrustful of such unregulated, abstract currencies, relegating their usage to a relatively small community of tech faithfuls. Hence, decentralization, which was the very inspiration for cryptocurrencies was threatening to also be their undoing.
Eventually, cryptocurrency developers began to realize that they had to create a use for their currencies to facilitate their acceptance by people. This led to the creation of digital commodities like NFTs (Non Fungible Tokens) and game items which could be traded using cryptocurrencies. But if cryptocurrencies were to become widely used by real people, they had to have real world applications like physical currencies. Hence, alongside the digital commodities, technologies entered into development to bring real world financial services like loans, insurance, exchange etc. to the decentralize world of cryptocurrencies. Such technologies are collectively known as DeFi (Decentralized Finance).
“Decentralized finance, or DeFi is the ecosystem of financial applications being built with blockchain technology.” - Camila Russo
As can already be observed, the lasting drive to make cryptocurrencies a viable means of conducting financial transactions, and the subsequent encapsulation of that idea as DeFi, is transforming the initially isolated, arbitrary currencies into a meaningful universe of entities with value and functions. This increasingly wholesome universe is a rapidly evolving unity, and the impacts of DeFi on its formation is given some attention.
Importance of DeFi
“Decentralized finance is an unbundling of traditional finance. DeFi takes the key elements of the work done by banks, exchanges and insurers today—like lending, borrowing and trading—and puts it in the hands of regular people.” - Rafael Cosman, CEO and co-founder of TrustToken.
The term ‘DeFi’ was coined in a 2018 chat between Etherium developers, but the idea has been around for a long time and can be identified as one of the inspirations for the development of cryptocurrencies and blockchain technology. DeFi basically aims to offer financial services on the blockchain on a peer to peer transaction basis. It includes both adaptations of traditional financial services from centralized finance (CeFi) organizations (banks) e.g. Decentralized exchanges (DEX), loans, insurance etc., and invented blockchain financial services like self paying loans, yield harvesting etc.
In centralized finance, consumers need to go through a number of financial middlemen to access any financial service - from getting loan to trading stocks and bonds. These middlemen like banks, exchanges and lenders also earn a percentage of every financial transaction as profit and this makes financial services expensive, less profitable and difficult to access. Hence, the main advantage of DeFi is that it eliminates these middle men in financial transactions, allowing interested parties to directly trade financial services in an accessible, open and transparent way.
These advantages have proven to be very popular among people. In 2020, the Total Value Locked (TVL) – a measure transaction value – for DeFi grew by 14x. The TVL quadrupled to a total value of $112.07 billion in 2021 and has continued to grow. This is causing a massive expansion of the crypto world as DeFi continues to explode in adoption.
DeFi related developments that are building up the crypto universe
DeFi is becoming very popular and there has been a speedy adoption of cryptocurrencies as a result of certain favorable developments from DeFi technology. These developments are revolutionizing the crypto world and they are discussed below.
1. Real world uses for cryptocurrency
Cryptocurrencies were initially seen by most people as limited, arbitrary products of wishful thinking with very little use in the real world. This was due to the fact that they were unregulated and thus had no backing from any trustworthy organization. Defi changed this entire narrative by inspiring the creation of crypto agencies and crypto supported services that could actually benefit people in the real world. These services include; crypto backed loans where one deposits crypto as collateral to take loans (BarnBridge), monetized blockchain gaming which creates real world jobs (Bitsport), decentralized insurance platform where one pays crypto premium to get risk coverage on real world or blockchain property (Nexus Mutual) etc.
Due to these real world uses, countries like Elsalvador and Cuba recognized Bitcoin as a means of exchange in 2021, transforming cryptocurrency into legal tender.
2. Blockchain digital commodities
Defi facilitated an entirely new business frontier within the blockchain in the creation and trading of commodities like coins, NFTs, game items etc. This monetization of the digital world basically transformed blockchain technology from just a medium of exchange to an entire business ecosystem. The blockchain is now like digital real estate supporting both exchange of currencies, trading of commodities and market place establishment.
3. Stable Coins
A stable coin is a cryptocurrency whose value is tied to a real world currency or item (e.g gold), thus, giving it a relatively fixed value. Stable coins where introduced to fix the volatility (constant rise and fall in value) problem with cryptocurrency that resulted in people treating them more like equity (shares) instead of money. This means that people held cryptocurrency hoping to sell them when the value rises and to buy when the value falls. With the introduction of stable coins, people can actually save money as crypto without worry of the value changing. Examples of stable coins are Tether (USDT), USD Coin (USDC), Binance USD (BUSD), TerraUSD (UST), and Dai (DAI).
Defi facilitated the creation of stable coins which enabled the use of cryptocurrency as a store of value - like bank deposits.
4. Cross chain technology (crypto bridges)
This is the ability to transfer cryptocurrency from one blockchain to another. Usually a digital coin is only transferable within the blockchain that it runs on e.g Bitcoin blockchain is different from the widely used Etheriuim blockchain which only supports ERC-20 tokens. Hence, it wasn’t possible to convert bitcoin to etherium until recently through cross bridging which allows this transfer to facilitate more transactions in the crypto world.
This is one of the biggest impacts of DeFi on cryptocurrency because it has facilitated the evolution of cryptocurrency from a means of exchange within a blockchain, to a means of exchange across blockchains. This puts an end to the limitations of Isolation on cryptocurrency. It also allows transfer of coins or tokens between Decentralized apps (Dapps) on different blockchains. Hence, investors have maximum ability to exploit opportunities in the crypto world. Binance Bridge 2.0 is an example of an app implementing cross chain technology and substrate is an example of a future proof framework which facilitates the creation of interoperable, multi-chain technology.
Cross chain technology has basically created an internet of blockchains and cryptocurrency.
5. CeDeFi
The term CeDeFi was invented by Binance CEO Changpeng “CZ” Zhao in 2020 during the debut of Binance Smart Chain by the company. CeDeFi, or centralized, decentralized finance, combines the greatest features of centralized and decentralized finance by allowing users to enjoy some benefits of DeFi without directly dealing with the protocols. Corporations can also use CeDeFi to experiment with new financial products while still following their established financial regulations. CeDeFi allows access to DeFi products like decentralized exchanges (DEX), yield farming tools, lending protocols etc. for a cheap price.
CeDeFi was inspired by the huge success of DeFi. With almost $250 billion of value in the DeFi ecosystem, even corporations are being attracted to DeFi. Though DeFi’s decentralized structure contrasts with their system, traditional financial institutions have been looking for a way to get into the developing DeFi ecosystem. CeDeFi, or centralized, decentralized finance, is the solution they found to this problem.
With the advent of CeDefi, DeFi can finally complete the Cryptocurrency network by linking decentralized users to centralized institutions.
6. DAOs (Decentralized Autonomous Organizations)
A DAO is an organization formed by users of Dapps which runs itself via smart contract without any central control. A DAO is funded by people who would like to invest in it. They obtain government tokens based on the size of their investment and these tokens are used to vote on what the DAO will promote in the blockchain. The money raised can then be used to fund projects that align with the goals of the DAO. All of this happens automatically through smart contract. An example of a platform that allows DAOs is Compound and the government coin is COMP.
DAOs are like companies and the investors are like shareholders. With DAOs, DeFi has basically evolved the blockchain into an economy in itself, where virtual corporations can be formed.
7. Decentralised Messaging
Messaging is an integral part of the internet, and it is being adopted in the blockchain industry. Decentralized messaging allows users on the blockchain network to exchange messages without a central server. It is more secure and affordable because of the direct peer-to-peer communication. Many blockchain projects are currently working on on-chain messaging services, which could eventually support off-chain interactions. Public blockchains like Ethereum are well suited for decentralized messaging as they provide powerful tools for developers to create these experiences.
Decentralized messaging is being developed to facilitate better financial transactions on the blockchain. Hence, DeFi is also evolving blockchain technology into a communication system.
Conclusion
With all these developments discussed, it is easy to see blockchain technology growing into a more active and dynamic, full fledged internet for devices running decentralized applications. DeFi is evolving cryptocurrency into a unity, the unity is taking form, and it appears like how web 3.0 was described.