More thoughts on decentralized finance

February 24, 2020 12:25
Decentralized finance (DeFi) is a major potential step forward in delivering on blockchain’s promise in the financial services arena, the author says. Photo: Reuters

January 2009 marked the birth of Bitcoin as Satoshi mined the genesis block – and the eleven short years that followed are a story of innovation, studded with milestone technical breakthroughs. As we proceed through 2020 it’s becoming clearer all the time that decentralized finance (DeFi) is another major potential step forward in delivering on blockchain’s promise in the financial services arena.

Through its evolution, various solutions have been explored to increase blockchain’s constraining issues of scalability and cost, including sharding, proof of stake, and of course Layer 2 solutions.

Enter DeFi

DeFi is the latest advance to inspire developers and market participants as a solid path to the kind of user-friendly, wide-scale decentralized financial products and services predicted from the beginning of blockchain. To recap, DeFi comprises peer-to-peer electronic financial structures leveraging cryptographic assets and blockchains to issue, trade and hold financial assets, offering easy access, transparency and improved interoperability.

Given its ability to link traditional real-world financial services with blockchain’s innovations, DeFi is now the next step in how developers, investors and users perceive the digital asset economy. For the first time, we’re looking at a viable proposition for significantly growing blockchain’s capacity.

One solution to enhancing scalability is to create interoperability: in short, ways of enabling single blockchains to communicate between themselves by transferring data between different kinds of chain. Consider the implications of this development as it overcomes the inflexibility of single blockchains operating in isolation, unable to communicate between themselves easily: to start with, it opens up the ability to replicate existing centralized financial products and services using smart contracts on blockchains, providing the functionality and ease of use consumers require without the need for (and cost of) an intermediary.

Advantages for traders

Such multi-chain environments also boost the scalability of decentralized networks by applying a multiplier effect, expanding the ecosystem of accessible cryptoasset holders who now have exponentially more routes to move, exchange or even cash out their assets for fiat across this much wider universe of users.

The potential benefits to members of DEXes (decentralized exchanges) that come under DeFi umbrella are unmistakable. With the scale of increased interoperability comes the potential for increased liquidity. Traders understand the benefits of liquidity well: better price discovery and the ability to deal in greater size without impacting pricing, due to the availability of a larger pool of buyers and sellers readily available to transact.

Capital efficiency

Greater availability of tradable assets and better pricing also means greater capital efficiency for participants in the form of lower fees and tighter price margins. Interoperability enables holders of different kinds of digital assets to pool these assets from across different chains, raising the possibility of building a virtual liquidity hub that remains decentralized. In addition, the security and trustlessness inherent in blockchain DApps remain unaffected. Early examples of DApps designed to share liquidity are already attracting increased depth, increasing the benefits that come with it.

In addition, sharing liquidity in this way opens up the possibility of creating a viable model of liquidity providers, in which owners of large inventories of coins can earn fees for making them available – another option to increase capital efficiency.

In short, collaboration between an ecosystem of diverse DeFi operators leveraging innovations that enable blockchains to exchange data shows all the signs of a significant step forward for DExes. As we investigate ways of enhancing scalability and therefore liquidity, we’re enthused by the possibilities opening up in this space – promising further developments just over the horizon.

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General Manager, OAX Foundation