By Anshul Dhir and Ankitt Gaur

“Necessity is the mother of invention” is a well-known aphorism. It means, roughly, that the driving force for most new innovations is a need. This stands true in the case of Decentralized Finance or DeFi as well.

DeFi is an emerging financial technology that combines the power of blockchain, digital assets and financial services, eliminating the role of ‘middlemen’ or an intermediary in the finance world. But, why you may ask? A simple reason is that traditional banking systems are not inclusive.

Let us explain it to you.

For instance, you visit a bank asking for a car loan. You would be asked to share all your banking documents, educational qualifications, salary slips, and declare all your assets—and even after that your loan application would be subjected to a ‘credit score’, that will eventually decide your fate. All of this hassle, despite harbouring collateral.

After you finally obtain a loan, then there will be a fixed commission levied on you by an agent (middleman) who is aiding you in availing the loan.

DeFi wants to disrupt this. It ensures that everyone who wants to borrow and lend has the right to do so, without the need of any ‘middleman’, albeit digitally and with full control over their assets.

Of course, to facilitate lending and borrowing a technology that is secure, and robust was needed. Blockchain came to the rescue. Since 2019, the DeFi market has grown at a breakneck speed. According to Defillama, the value of cryptocurrency locked into DeFi services increased from less than $1 billion in 2019 to $236 billion in November 2021.

Problems with Banking systems

It is essential to comprehend the current problems with the banking systems, to get a clear picture of DeFi.

The main purpose of banking systems is to facilitate transactions, whether locally or globally. It might be easy to transfer money locally but that’s about it — try sending remittances abroad and you are met with walls of red tape and fees for middlemen.

In terms of funding, when most people invest, they are essentially passing over the control to intermediaries, or so-called ‘professional managers’, who are posed as wise money managers of the financial market. All your gains are their gains and all your losses are only yours. This way they will end up making higher returns than the investors.

This also means that most people relying on traditional finance don’t have control over their money. In reality, banks use that money in ways that most people don’t understand. In times of emergency, bank runs can quickly lead to zero cash balances, as seen in places like Argentina, Venezuela and Zimbabwe.

After the 2008 Financial crisis, hundreds and thousands of people lost their fortunes as banks went under. The banking systems even tried out manipulating currency valuation, as was the case with China.

Concerned by the threat posed by the current global financial systems, many people are looking to emerging technologies to shield themselves, in this case, DeFi systems.

Now the big question is: What does the future look like? Will DeFi replace traditional banking?

The Winner

One thing is clear, the need for an open, transparent and secure system is the fundamental driver in the whole public debate between traditional banking and DeFi. It is no surprise that millions of people rely on DeFi today, which is slowly but steadily becoming an alternative to financial systems.

These systems can be a financial tool that is outside of government and regulatory control, meaning that it is for the people, and by the people.

Data security becomes a rising concern when it comes to financial systems. DeFi gives you an edge over your data.

It has made it possible for people to attain full control of their assets and their financial data when transacting in the global financial sector. So be assured of no more third party calls for marketing and sales.

Further, the use of open-source code and developer tools presents a special opportunity, as developers would now be able to experiment with more financial instruments as decentralized finance continues to gather pace.

This means no more hang-time or ‘lunch-time breaks’ as developers will be able to work around the clock without restrictions, boosting financial products and instruments in the financial sector.

Blockchain technology can make all the processes starting from loans to collateral tokenised. This means everything will be paperless on smart contracts, easily readable by machines and humans.

Co-existing

Undoubtedly, the financial landscape is changing. It has become pertinent for financial institutions to embrace DeFi, as a long-term business model.

While it is understandable that banks and traditional systems might feel threatened by the emergence and widespread adoption of DeFi but time will take its course.

This was the case with Blockchain as well. Banks were initially skeptical about it, however, with countries like India, Canada, China, and the UK exploring a Central Bank Digital Currency (CBDC), this is bound to happen.

Not to forget that several banks have already started investing in crypto and blockchain-related firms. This shows that as nascent as it sounds, banks are actively learning from blockchain adoption and incorporating it.

The same applies to DeFi space. Banks need to understand that DeFi is a natural ecosystem coming out of blockchain technologies and it is here to say—and is unstoppable.

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The authors are co-founder and COO, EasyFi Network, and founder and CEO, EasyFi Network, respectively