Down The Rabbit Hole - The Mesmerising Future of DeFi and the Dangers Lurking Ahead
Updated: Jan 1, 2022
Blockchain and its most famous application, cryptocurrency, have exploded into a trillion-dollar industry today, sparking a huge wave of financial disruption. Call it a fad or a real deal, cryptocurrencies have taken the world by storm and no one can close their eyes to it. The digital currency scenario is a brimming space for entrepreneurs and market investors alike today.
At the heart of cryptocurrencies is the cryptography innovation that dated back in the 1980s. Since its humble beginnings, that remarkable innovation has morphed into the launch of various cryptocurrencies, the most prominent which is Bitcoin. The first official use of Bitcoin for a commercial transaction with an actual company was recorded in 2010, when Laszlo Hanyecz spent 10,000 Bitcoins at a local pizza restaurant called Papa John's to buy himself two pizzas. Considering the value of Bitcoin today, which is well over $60k currently, these two pizzas can be regarded as the costliest pizzas of all time, costing over $300 million each. 😂😂😂
Despite its spectacular growth over the last decade, the use of Bitcoin as a mainstream financial tool is still facing several obstacles, mostly due to its inherent lack of stability and adoption. Mainstream institutions won’t accept a Bitcoin loan because of its significant price volatility — it makes Bitcoin a poor asset to plan any investment accurately.
Things change quickly in the crypto space, and decentralised finance (DeFi) is a current trend, and undoubtedly an exciting space to be in, and the hottest buzzword in the capital markets the last 12 months or so… So what exactly is DeFi? Let’s dig a little deeper into DeFi and learn more about it.
DeFi is an umbrella term for a variety of financial applications in cryptocurrency or blockchain geared toward disrupting financial intermediaries. Inspired by blockchain technology, DeFi refers to financial applications built on blockchain technologies, typically using smart contracts. A smart contract is a self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of software code. The code and the agreements contained therein exist across a distributed, decentralised blockchain network. The code controls the execution, and transactions are trackable and irreversible.
DeFi consists of applications and peer-to-peer protocols developed on decentralised blockchain networks that require no access rights for easy lending, borrowing, or trading of financial tools. Most DeFi applications today are built using the Ethereum network, but many alternative public networks are emerging that deliver superior speed, scalability, security, and lower costs. Some of the notable networks are Binance Smart Chain, Polygon, Polkadot, Solana etc.
The most popular types of DeFi applications include:
Decentralized exchanges (DEXs): Online exchanges help users exchange currencies for other currencies, whether it is for US dollars for bitcoin or Ether for DAI. DEXs are a hot type of exchange, which connects users directly so they can trade cryptocurrencies with one another without having to trust an intermediary with their money.
Stablecoins: A cryptocurrency that's tied to an asset outside of cryptocurrency (for example the US dollar or Euro) to stabilise the price.
Lending platforms: These platforms use smart contracts to replace intermediaries such as banks that manage lending in the middle.
"Wrapped" bitcoins (WBTC): A way of sending bitcoin to the Ethereum network so the bitcoin can be used directly in Ethereum's DeFi system. WBTCs allow users to earn interest on the bitcoin they lend out via the decentralised lending platforms described above.
Prediction markets: Markets for betting on the outcome of future events, such as elections. The goal of DeFi versions of prediction markets is to offer the same functionality but without intermediaries.
Moving forward, let’s head to Alice in DeFi-land and look at why DeFi is so intriguing and the dangers lurking around the corner…
“The rise of an ecosystem of financial services, known as decentralised finance, or DeFi, deserves sober consideration. It has the potential to rewire how the financial system works, with all the promise and perils that entails. The proliferation of innovation in DeFi is akin to the frenzy of invention in the early phase of the web. At a time when people live ever more of their lives online, the crypto-revolution could even remake the architecture of the digital economy.”
- The Economist
DeFi is One of Three Tech Trends Disrupting Finance
The Economist believes that there will be three major innovations in the future of finance:
1. The significant advantages of technology platforms at the payment and banking level;
2. The government-issued digital currency (CBDC) will change the existing currency structure;
3. DeFi provides a decentralised financial model. This is based on the characteristics of open blockchain, no access, and no central control entity.
DeFi is More Effective than Centralised finance
Traditional financial institutions need a complete set of infrastructure, liquidation, compliance, and capital requirements. These infrastructures are all for one purpose - to build trust among strangers. The characteristic of DeFi is trustless, so theoretically, without these costs, it is more efficient and low-cost than traditional centralised finance.
The Level and Scope of Services Provided by DeFi Are Increasing
DeFi activities such as lending, trading, and derivatives are all carried out through smart contracts, and the most wonderful thing is that collateral, the cornerstone of finance, is also composed of digital currencies. The size of the $2 trillion collateral market is still increasing. Ethereum's transaction volume reached $2.5 trillion in a quarter, which is very impressive. In the recent upsurge of NFT and pixel, DeFi provides the support of the bottom layer of payment and ownership functions.
On the flip side, it is not all sunny and rosy…
The current mainstream blockchain protocols have not yet been able to achieve high speed transactions. In order to achieve decentralisation, it consumes a lot of power (this point is open to discussion), and once the system load becomes big, the cost of the network will rise sharply. The re is no clear consensus of the choice of underlying blockchain layer, could be Ethereum or maybe something else.
The Trouble With the Interaction Between the Virtual World and the real World
How the virtual economy behind DeFi interacts with the real world is a big headache. On the one hand, where is the value of digital currency anchored? The source of value of digital currency lies in people's expectations for future use, while the source of value of legal currency lies in the endorsement of the state. Because the two sources of value are different, how to anchor becomes a huge problem. If the anchor of value is unstable, DeFi will become fragile. On the other hand, how to match virtual property rights and real property rights has not yet been answered.
The Attitude of Existing Governments
DeFi transactions are irreversible and non-human, which leaves the powers held by the states nowhere to be placed. Some inherent problems such as money laundering and false decentralisation may destroy this system. These problems are partly outside the reach of state control.
DeFi Still Needs to Be Integrated With the Real World
The new chairman of the SEC, Gary Gensler, believes that DeFi operating entities must be regulated, and the Bank for International Settlements even suggested that government-issued digital currencies should also become the cornerstone of DeFi.
Innovation Never Ends
Just as in the 1990s in the 20th century, no one knows where innovation would end… but one thing is for sure, they would definitely change the existing financial structure and the entire digital world.
Please check back to our blog as we produce more content pertaining to travel and tourism industry, and how xTripz Network will utilise the technological advancement in blockchain and decentralisation to build the world’s first community-owned decentralised travel experiences platform.
About xTripz Network:
xTripz Network aspires to become one of the best travel booking site in the world, one which is fully decentralised and community owned and governed. The xTripz platform facilitates discovery, shopping, booking and payment of travel products, with novel DeFi and NFT features, replacing travel gift cards with our $XTR travel token, and providing our users memorable travel experiences and wide offering of travel activities. Our travel guides provide up to date information, including popular searches on travel activities, glamping near me and travel cryptocurrency.