Decentralized finance (DeFi) is currently experiencing soul-searching. Since Terra’s collapse in May and those platforms that were severely affected by it, there has been a widespread perception that DeFi offers little more than circular lending and recklessly leveraged speculation, which has the potential to end up causing a domino effect of failure if one domino tumbles.
Since the downfall of Terra resulted in other linked collapses, there is some validity to this skepticism. Even so, statistics in the crypto and DeFi sectors confirm that DeFi is still a young field that will mature and solidify as it evolves.
Undoubtedly, many assert that DeFi will become more integrated with legacy finance in the coming years. At the same time, it will also find applications in areas other than finance, such as the Internet of Things, digital ID, and data storage. And the more frequently it does, the less it will be centered on the risky exercise of lending and borrowing nearly entirely for speculation.
The potential of DeFi’s, apart from speculation.
Since Terra’s de-pegging and collapse in May, there has been no scarcity of criticism directed at DeFi.
In reaction to many platforms venturing in to help stabilize the sector, industry experts stated in late June that most decentralization posturing in crypto is ambitious and, at worst, just blank marketing.
And MetaMask co-founder Dan Finlay said in an interview with Vice in July that “many of the collapses that happened during this last round were things that were branding themselves as DeFi but then were actually kind of operating as shadow banks with massive leverage.”
In reaction to the summer’s collapses, one expert even recommended that “DeFi is dying.” At the same time, two other influential crypto critics, David Gerard and Amy Castor, teamed up on a “dead and dying list” for Defi in late June. In the meantime, FTX founder Sam Bankman-Fried likened DeFi yield farming to Ponzi schemes.
All of these critiques boil down to the fact that excessive DeFi entailed highly leveraged speculation – platforms would accept deposits from users after pledging high yields and then utilize these deposits to loan to other platforms or invest the deposits elsewhere. Given the crypto market’s infamous volatility, speculating with wealth collected from others is seldom a good idea.
Even so, many supporters of DeFi in the crypto industry believe there will be growth in the space and, eventually, deliver on its pledges. According to Jason Ma, the director of business development at Web3 infrastructure network Axelar, DeFi is a natural development of the current financial system.
“DeFi eliminates intermediaries and central oversight, making financial markets more accessible to retail investors and creating new investment opportunities. Decentralization democratizes banking and finance by ensuring easy access to financial services for everyone, particularly in developing countries,” he said.
Talking about the sector’s potential, Ma claims that DeFi benefits from using blockchain technology in various ways, including transparency, which can aid in users identifying and avoiding possible financial frauds and harmful business practices. Similarly, smart contracts offer additional protection against malicious actors and fraudulent transactions.
Other experts also agree concerning predicting the future potential of DeFi, even though such potential is yet to be realized.
“DeFi is potentially one of the most compelling use cases for cryptocurrencies, as it enables the execution of any business logic on-chain, in a transparent and trustless manner,” said Till Wendler, the co-founder of economy-of-things blockchain technology provider peaq.
This type of evidence is easy to find, with crypto pundits making bold assertions on behalf of DeFi and what the long-term outcome will be. DeFi is a “critical component” in developing a more inclusive global financial system, according to Pedro Isaac Lopez, Chief Growth Officer at THORWallet DEX.
“By removing the need to rely on intermediaries, DeFi makes traditional banking services far more accessible, opening up the array of innovative tools enabled by blockchain technology. These services and tools include swapping, borrowing or lending, producing yield from crypto assets via pooling, and yield farming,” he said in an interview.
Lopez claims that, even after the recent downturn and subsequent collapses, the value of the ecosystem’s DeFi platforms is around USD 70 billion, according to DefiLlama. He is confident that this demonstrates the solidity of DeFi and suggests that it will eventually be used to allocate and control capital more efficiently and adapt to changing market conditions in previously impossible ways.
The present and future of DeFi
Skeptics will likely argue that such ambition has yet to be realized and may never be. There are numerous examples of DeFi platforms achieving things now rather than just hinting at a better future.
“For example, the MakerDAO community recently passed a proposal to integrate a US bank into its collateral system,” said Jason Ma, referring to the US-based Huntingdon Valley Bank, which currently has a USD 100 million debt ceiling with MakerDAO after Maker’s community voted to concede it into its ecosystem.
Maker also recently voted to invest USD 500 million in DAI in US treasury bills and corporate bonds, indicating that DeFi has begun to play a role in capital allocation to the global economy. If you believe that banks, treasury bills, and bonds benefit the global economy, you may also believe DeFi benefits.
Till Wendler agrees that more leading DeFi protocols are looking for exposure to real-world assets, citing examples of business-to-business lenders using DeFi to invest in companies that provide real-world services, such as Fairmint.
“We’ve seen some momentum in the crypto mortgages. The industry is slowly, but surely moving toward real-world outcomes, and that’s exactly where it should be heading if it wants healthy yields and services,” he said.
DeFi has begun transforming the real estate, insurance, and crowdfunding industries, among others, says Naureen Mustafa, Lisk’s Head of Exchange Development,
DeFi, for example, is removing the need for paperwork and all intermediaries in the real estate industry. You can now buy real estate tokens or even entire property by signing a transaction with your digital wallet and becoming an asset owner without involving banks, realtors, or government agencies, among other things, she said.
The partnership announced in June between Teller Protocol and Tower Fund Capital, which will see Teller depositors receive interest payments for funding mortgages and loans awarded by Tower Fund Capital, is a recent example of the merging of DeFi and real estate.
Such collaborations are just the beginning, but they demonstrate that DeFi is growing and that it isn’t just a leverage mechanism for crypto speculation.
Whereas speculative lending and borrowing applications have experienced the highest rates of adoption, the whole DeFi sector is still in its infant stages. There is confidence that it will broaden to include corporate finance, real estate, content production and distribution, and other areas, according to Mattias Tengblad, CEO and co-founder of blockchain-based crowdfunding platform Corte.
Many others believe that DeFi is still in its early stages and that the recent crises experienced by Terra and Celsius will only help it mature.