A Quick Commentary on the De-Fi Ecosystem

De-Fi is the Cryptocurrency wave’s take on how banking, borrowing, lending, and saving ought to work. In line with the general principle of Blockchains, Decentralised Finance denotes the collection of financial products on a decentralized public Blockchain network. Instead of going through middlemen like brokerages, banks, and other financial institutions, De-fi allows users to access these products and services freely. The software coded into the Blockchain allows for lenders, sellers, buyers, and borrowers to interact as peers on the P2P network, with the software serving as a middleman.

Smart contracts then automate and record the agreed terms between the buyers and the sellers, lenders, and borrowers. The main selling point for decentralized Finance seems to eliminate the intermediary role between two or more transacting parties. The regulatory framework in the De-Fi industry is still in its formative stages, even as the Blockchain network continues to grow.

The concept of De-Fi uses technology to disintermediate traditional centralized models, which in turn allows for anyone anywhere to access these financial services regardless of geography, ethnicity, or age. Trading services and personal wallets are features that make De-Fi Blockchains an attractive prospect for many users. People are better able to exercise control over their money in a system that has been explicitly designed to cater to the individual rather than institutions.

Within De-Fi, investors also earn as much as 100 times the interest that traditional banks and brokerages offer. Owing to the rig-rag nature of the De-Fi nature as yet, these deposits are, however, not protected by the Federal Deposit Insurance Corporation (FDIC), which leaves these said deposits highly susceptible to technical, infrastructural error, market crash conditions, and cyber-attacks.

To explain why De-Fi deposits earn yields; crypto banks do not need to have deposits as required by law, which would ensure that clients can still withdraw money, even if their loans with the traditional bank go bad. This means that crypto banks do not have the same reserve requirements, hence can afford to take bigger bets than conventional banks.

So, the BlockFi Industry, as it is popularly known, lends its money to seasoned institutional investors and hedge funds, which then take advantage of the Crypto markets’ irregularities and bet on discrepancies that then generate higher returns for them allow them to take even more significant risks.

Components of a De-Fi Network

All the components of a De-Fi system come in the form of a software stack, with each Layer designated to perform a specific function. The following are the four layers that typically constitute the De-Fi stack;

1. Settlement Layer — the public Blockchain layer that also has its digital cryptocurrency — also called Layer 0. It is the foundational layer upon which other De-Fi transactions are built. The Settlement Layer might also have tokenized versions of assets, which are digital representations of real-world asset classes, such as a real estate token representing the ownership of a parcel of land. An excellent example of a Settlement Layer is Ethereum and its native token, ether (ETH).
2. Protocol Layer — this is the set of rules and principles that the financial industry has agreed to run on. In the real world, these would be financial regulations and fiscal statutory laws. In the De-Fi ecosystem, these laws are software protocols written to govern a particular set of tasks or activities. De-Fi protocols are interoperable, with the inbuilt ability to execute for different users or applications simultaneously. This Protocol Layer’s primary role is to provide liquidity to the De-Fi ecosystem. An example of a Protocol Layer is Synthetix, the derivatives trading protocol on Ethereum.
3. Application Layer — this Layer contains consumer-facing applications. They are the easy-to-use interfaces that mask the underlying software protocol layer. The most common applications found in this Layer include crypto lending services and decentralized crypto exchanges.
4. Aggregations Layer — the aggregation layer connects the applications to external financial services. An excellent example of the aggregation layer at work is the aggregators that allow the seamless transfer of money between different financial instruments for investors to maximize return. Examples of services existing on this Layer include; crypto wallets, banking services, and lending and borrowing services.

What is the current state of the De-Fi Industry?

Decentralized Finance is still in its beginning stages of development. The majority of the users in this Blockchain network are early adopters, with the total net worth locked in De-Fi contracts standing at $41 Billion as of March 2021. That being said, the De-Fi ecosystem is still riddled with hacks, scams, and the general insecurity of the infrastructure. There are also regulatory hurdles to be crossed regarding the use of De-Fi tokens, considering that current regulation consists of every jurisdiction enforcing its own set of laws. The borderless nature of De-Fi tokens poses regulatory questions that need urgent answers.

To summarize, De-Fi is an alternative universal finance ecosystem where users can borrow, lend, transfer or trade crypto, independent of traditional financial institutions and the financial regulatory framework. The De-Fi wave’s objective is to disintermediate Finance, using computer code to eliminate the need for trust systems and intermediaries from financial transactions.