With new technologies and innovations popping up from even the most unexpected places, it is no surprise that finance is seeing a revolution like never before in recent history. One of the most radical aspects of this financial revolution is the possibility to manage assets without the need for a centralized agent. This is not new, but the scale at which it is occurring, thanks to technology, is unprecedented.
Although the idea of a decentralized financial system is very attractive and can offer many benefits, it also poses risks. Decentralization does not mean that anyone is free to do whatever they want. Rules need to be in place and the agents involved need to understand how the system works. When all of this is considered, it seems that there is room for improving how the existing financial system works.
Understanding decentralized finance is essential to figure out where the industry is headed. In this post I’ll discuss what it is, its importance, and how apps can be a part of this revolution.
What Is DeFi?
Decentralized finance, also known as DeFi, is a financial system that exists outside the formal and centralized one. It operates with no centralized agent, so there is no need to ask for permission about what can or cannot be done. This implies that there are no intermediaries, other than decentralized platforms, so there is a reduced or non-existing need for paperwork. Because it is not coerced by specific laws and regulations, it can operate across countries through the internet.
DeFi innovations are highly dependent on Blockchain technologies. Most initiatives are built on cryptocurrency platforms like Bitcoin and Ethereum. It is in these platforms where users can perform all sorts of transactions with other users from all over the world. Traditional financial services are present on these platforms. Transactions, investments, and exchanges are just some of them.
These systems function under the logic of a smart contract, another Blockchain-based technology. A smart contract reacts to events in the external world automatically, so users don’t have to update it or make any changes. This means that even though there is no central agent, they can operate in a transparent and conflict-free way. Blockchain prevents the information in the chain from being modified by any agent, helping avoid frauds and scams. This is possible because the information lies on a distributed open ledger where everyone has access to perform audits to the transactions chain.
The Importance of DeFi and Its Evolution
Throughout 2020 the total value locked in DeFi systems has skyrocketed. By January 2020, it was around 700M, and by August it had already surpassed 7B. Part of this can be explained due to the pandemic and people looking to diversify their assets as a consequence. However, this is not the only attributable explanation. Yes, the pandemic might have triggered some people to invest in these new systems, but it also shows that, technologically speaking, decentralized alternatives are strong enough to drive people’s attention and generate trust.
The fact that decentralization helps reduce friction for financial operations is one of the key success factors of this phenomenon. By eliminating intermediaries it is possible to reduce costs, make processes more efficient, and empower asset owners to decide on what’s best for them. For many, this is very attractive when compared to traditional centralized systems in which they have to delegate control over their assets, pay administrative fees, and where processes usually take time.
This situation can be interpreted from two perspectives. The first asks us to consider the future of decentralization. What signals can we read at the present moment that can shed some light on where the sector is heading? Most likely, we can expect it to keep on growing until it reaches a plateau. The question is whether this will occur anytime soon. There are reasons to believe that there’s plenty of room for growth.
The other perspective to consider is that of traditional centralized systems. How will conventional agents react to this threat? Realistically speaking, governments will have to make important decisions on how financial regulation will evolve. Also, traditional finance isn’t going to disappear anytime soon. They will have to adapt, and part of that process will surely involve modifying existing regulatory practices to level the playing field.
Like anything Blockchain-related, there is still a lot of uncertainty on how things will end up evolving. Many challenges lie ahead for traditional and decentralized systems; some experts are even suggesting the possibility of a bubble. However uncertain everything is, we can expect many changes in the financial landscape. Consumers and governments will have the last word.
One thing for sure has helped grow the decentralization of financial systems: innovation. It is no coincidence that there is a strong relationship between this growing industry and HiTech technologies like Blockchain. In general, decentralized projects are prone to be greater risk-takers, defying the status quo along the way.
Many interesting projects exist in this new decentralized market. Nonetheless, the reality is that, like in the recent history of new markets, most new companies will be gone in a few years. Staying relevant will be the challenge that many companies face. This entails quite a few things. For a start, it is necessary to experiment constantly. Only the companies that do so will be able to deliver great products that users love and that governments approve. A good way to start experimenting is through the use of FinTech sandboxes.
There is also a great deal for decentralized financial companies to experiment in terms of tokenization. Crypto tokens are a subset of cryptocurrencies, which are often thought of exclusively in terms of altcoins like Bitcoin. Tokens are another type of digital currency, but they go beyond ‘money’. Tokens also rely on Blockchain, but they cover a wider range of other valuable assets. Think for example of points from a customer loyalty program or listening hours from a music streaming service. In general, crypto tokens are referred to as crypto assets because they cover a wide range of items. We will surely see how companies experiment tokenizing things that we can’t even think of.
Aside from experimentation, we can also expect to see how companies experiment with decentralized and more complex financial products. Investment platforms and financial products that are only available today to powerful asset management companies will surely become democratized. However, there is also space for new simpler products to appear. It all comes down to how creative the industry can become. Well, that and one additional thing.
Having a product or service that delivers great value to users is awesome, but if that can’t be translated into something that people actually use, then it is worth nothing. That’s where apps come into the scene.
Companies that manage to deliver outstanding user experiences will be the ones that stand out when all other factors considered are the same. It is necessary to hit the market with a product that users love, that is easy to use, intuitive, and that can deliver a secure and reliable experience. Failing to do so will only end up tarnishing the image of any product or service because users want the best when it comes to their assets.
Building a FinTech world-class app is not a task that should be assigned to just anyone. You will surely want someone with the necessary development and design skills, but also someone who knows the intricate details of the industry. In other words, you need a strategic development partner.
At Koombea, we’ve been building state of the art FinTech apps for over 12 years. We understand that it’s not only about the code, but also about how you build your app to meet your business needs in a strategic way for the long term. That’s why we see ourselves as a strategic development partner rather than just an app developer.
If you want to experiment about what can surely be the next thing in finance through an innovative DeFi app, contact us.