Byline: Kaitlyn Gomez
Over the past few years, decentralized finance (DeFi) has evolved from a niche field to a more serious competitor against traditional banking. As more people entrust cryptocurrency as a legitimate asset, other blockchain-supported technologies will soon follow. It’s easy to see why individuals would prefer to use DeFi over traditional banking. It provides peer-to-peer lending, secure exchanges, and minimizes transaction fees.
It’s important to note that in the greater world of blockchain, the Bitcoin price is often used as an indicator of the market’s performance. In addition to stablecoins, BTC could become one of the most used currencies around the world in places that accept payments in cryptocurrency. As DeFi reaches greater maturity, it’s essential for users to understand how the infrastructure works, why it is challenging the fundamentals that uphold legacy banking systems, and what this could mean for the future of financial services.
DeFi’s Increasing Popularity: Beyond Traditional Banking
Lending and Borrowing Without Intermediaries
When considering borrowing money, many people’s first thoughts are about who will lend them the money and what the interest rate will be. Now imagine that you could borrow money without any intermediary at all. It’s hard to imagine, right? In traditional banking, deposits are pooled among all lenders and then loaned out through a central intermediary.
DeFi uses the exact opposite system. Instead, users can put their assets into lending pools while others can borrow using smart contracts. Interest rates will adjust depending on supply and demand. This system ultimately reduces friction and allows anyone with a crypto wallet access.
Yield Farming and Liquidity Mining Add Incentives
One of DeFi’s most alluring features is yield farming. This is where users provide liquidity to protocols, such as buying a token, in exchange for automated rewards. This system meets users and companies in the middle, allowing both to benefit. Since yield rates can significantly outperform flat bank interest rates, users can instead put capital in DeFi systems to increase their regular yield.
Why DeFi Appeals to Users and Outperforms Banks
When breaking down the two systems, it’s easy to see why decentralized finance can easily outperform banks.
One major benefit of DeFi protocols is having 24/7 access to your funds. Traditional banks have limited operational hours. They are often not available on holidays, weekends, or evenings. DeFi protocols are available at any time because they are constantly running on the blockchain.
Composability gives individuals more autonomy over their finances. Think of DeFi like interlocking building blocks. You can interconnect one protocol with another and create modular financial stacks. For example, you can borrow from Protocol A while your collateral is tied to Protocol B.
Additionally, transparency is greater in DeFi since the blockchain is an unchangeable mathematical algorithm. The blockchain makes it easier than ever before to prevent fraud and ensure your transactions are secure. Banks, on the other hand, often handle transactions without much transparency as to where your funds may go.
Adoption in the Real World: Non-Crypto Businesses Take Interest in DeFi
You don’t necessarily have to be a cryptocurrency fanatic to get involved in this new system. Even non-crypto-related companies are buying BTC or are investing in firms that hold large reserves of BTC as part of their long-term investing strategy. Some corporations are also exploring how to implement decentralized finance into their own operations, including investments in DeFi projects or yield strategies, as mentioned previously. As investors re-evaluate the growing potential of digital assets, the necessity for DeFi also increases.
Most notably, MicroStrategy has become the leading corporate holder of Bitcoin and frequently acquires more BTC as part of its reserve approach. This shift at the institutional level demonstrates the power of the crypto-backed strategies and how even some of the wealthiest companies are looking to back this strategy.
Challenges That Could Stall DeFi’s Growth
One issue that is prominent in the news is the uncertain legislation surrounding cryptocurrency. Governments worldwide are still creating frameworks for how to regulate lending, stablecoins, and taxation on digital assets. Some jurisdictions are opposed to cryptocurrency use, while others are in favor of it due to its potential economic benefits.
Additionally, since DeFi is still a relatively new system, using existing platforms may not be as seamless as a regular bank. Users unfamiliar with the blockchain may have trouble setting up their digital wallet, or may be intimidated by the lack of DeFi options available.
DeFi: On the Path to Maturity?
While DeFi is not going to entirely replace traditional banking soon, it’s steadily becoming more relevant in automated, digital financial services. While still a pervasive myth, DeFi isn’t just a crypto-related fad; it’s an entirely new financial structure. As it gains strength, the institutions that adapt to the technology will continue to shape the future of finance. If traditional banks and financial firms want to keep up, it might be time for them to consider an adaptive approach rather than resisting this transition.