Why 2020 was a year of explosive growth for DeFi and 2021 will be too
Decentralised Finance or “DeFi” for short has had tremendous traction in 2020, even during the COVID-19 epidemic.
The ecosystem has grown by billions just this year, surpassing $15B in December (source: https://defipulse.com/). People have been drawn to the DeFi space because it offers new suites of financial tools and services that you cannot get in the traditional financial system, and people have discovered how cryptocurrency offers these capabilities. Additionally, interest rates have been historically higher than in the traditional financial world, making it extremely attractive for depositors looking to maximize their passive income.
DeFi in short
DeFi is an umbrella term for the ecosystem of financial tools built on the blockchain that do not rely on any centralised institution, like a bank does. DeFi uses open-source networks to create financial products and services. These records are kept via a network of smart contracts on the blockchain across a vast number of computers, so the ecosystem is very resistant to failure at a single point. One of the major benefits is that DeFi services have a near zero cost of entry, as the services can be accessed from anywhere in the world 24/7 as long as you have internet access.
Why has DeFi exploded in 2020?
As the technology behind DeFi matured, it began to attract new people to the space. The user experience has improved significantly over the past few years, and now DeFi tools and services have become more seamless for new user onboarding. One major factor driving the growth of the space is the open-source nature of the ecosystem. Because code is publicly accessible, developers are able to innovate at the speed of light compared to the closed-off traditional financial system. Thus, different “money legos” can be built, or different financial instruments that plug into and complement each other. These various tools can be assembled together to make inventive new products, rapidly expanding the opportunities in the ecosystem.
In 2020 DeFi and cryptocurrency lending caught the eye of financial experts and institutional investors. Although DeFi got its roots by aiming to replace traditional banking, major banks such as Goldman Sachs have actually started to explore how the technology behind DeFi can be used to complement the existing financial system. What started off as an avant garde technology has now matured and is moving towards mainstream adoption. DeFi, FinTech, and traditional finance are poised to intersect with the potential for new financial tools and service to be created.
London, an emerging DeFi hotspot
More and more DeFi projects are popping up in London, which has already made a name for itself as the FinTech capital of the world. At first FinTech companies and banks have been focusing on improving the frontend for an easier user experience, and now DeFi is helping innovate on the back-end side.
London-based Aave, one of the top DeFi protocols for lending and borrowing cryptographic assets, was granted an Electronic Money Authorization in July by the UK Financial Conduct Authority (FCA). This means that Aave will be able to issue electronic money accounts and facilitate currency conversions, making it even easier for new users to purchase cryptocurrency and start taking advantage of Aave’s services.
With Brexit on the horizon, the UK is trying to assert itself as a digital finance powerhouse, and regulatory powers are following suit. However, if DeFi is placed under heavy regulations, it runs the risk of stifling innovation in the space. DeFi natives often advocate for “self-regulation” where DeFi protocols set and uphold industry standards for security.
What comes next?
As DeFi continues to grow in 2021, more retail investors, as well as institutional investors, will become more entangled in the space. Since it is a new technology, many people do not fully understand the risks associated, and this could be an issue for retail investors. However, decentralised insurance alternatives like Nexus Mutual have already arisen to alleviate these risks for investors. Regulators in the UK are already proposing regulations for stablecoins, cryptocurrencies pegged to an underlying stable asset such as gold or GBP. Additionally, UK regulators are researching central bank digital currencies as a cash alternative.
Even amidst the COVID-19 crisis, the crypto space is on everyone’s mind. 2020 was the year that institutions started to buy Bitcoin, shining a spotlight on cryptocurrencies. DeFi is beginning to get the needed attention from institutions, traditional banks, and FinTech companies to move the space toward the mainstream arena.