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Blockchain technology has enabled permissionless networks that can be used by anyone, where built-in economic incentives ensure that network services can be maintained indefinitely without the aid of any individual company or central authority. Similar to how Internet protocols enabled a Cambrian explosion of network applications and services that are still expanding to this day, blockchain networks are enabling a growing number of existing services to be provided in a more decentralized way, without reliance on central authorities or intermediaries. One market segment that is experiencing rapid innovation as a result of blockchain is the financial services industry. Blockchain-based alternatives to traditional financial services have come to be called decentralized finance, or DeFi.
What is DeFi?
The advent of public blockchain networks like Ethereum have enabled peer-to-peer transactions of value to be executed programmatically based on a set of conditions through “smart contracts”, which are simply pieces of code that are deployed and executed on the blockchain. Applications built with smart contracts are colloquially called decentralized applications, or ‘dapps’ for short, and have been a major catalyst for the increasing exploration of cryptocurrency, or digital currency, for its use in industry. In practice, DeFi services are dapps that leverage the power of smart contracts and the decentralized nature of public blockchains in order to provide globally accessible financial services such as:
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Lending & Borrowing
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Spot Trading
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Asset Exchange & Swap
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Savings & Yield Products
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Stablecoins (Fiat-pegged cryptocurrencies)
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Insurance
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Prediction Markets
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Arbitrage
DeFi could help reduce the global gap in financial inclusion
While much of the attention and investment in decentralized technologies today is driven by speculation, the underlying value and impact of these technologies are critically important. For example, in many parts of the world, fundamental financial services are either inaccessible or inadequate due to a myriad of challenges such as i) economic underdevelopment, ii) poor infrastructure, iii) regulatory challenges, etc. For perspective, from the global research conducted by the World Bank and Gallup on financial inclusion around the world, studies in 2017 showed that ~1.7 billion adults aged 15+ did not have access to simple bank account services1. Even in well developed economies, both the access to and quality of financial services one has access to is dependent on one’s socioeconomic class. For example, according to a 2019 survey by the FDIC, 22% of the United States are classified as unbanked or underbanked, with large swaths of that population being those with lower income or less education. With this distinct challenge as a backdrop, it is evident that the development and adoption of open, borderless financial services can help bridge the widening gap in financial inclusion and opportunity around the world.
How to get involved in the DeFi ecosystem
Whether by providing savings and lending opportunities to unbanked or underbanked persons around the world, enabling global communities to access a wider variety of asset classes, or offering reliable alternative ways to hold and earn interest on savings, DeFi is evolving at a rapid clip that echoes cycles of growth and subsequent consolidation in the history of technology. With user growth and demand consistently increasing across diverse user groups, virtually every public blockchain network is prioritizing DeFi as a use case by providing tools, features and grants for developers to create the next big DeFi project. Today, the majority of DeFi services and products are being developed and actively utilized on Ethereum, and that trend is likely to continue. AWS supports open-source, public Ethereum networks in its Amazon Managed Blockchain offering, which reduces the overhead required to create and manage full nodes for the public Ethereum mainnet as well as the Ropsten and Rinkeby testnets.
Decentralized
Rather than centralized institutions, code acts as the only intermediary in the process. Changes to that code are most often made democratically by way of community governance voting.
Open & permissionless
Access is open and borderless; whether you want to create their own DeFi application or simply utlize an existing one, your ticket to entry is an internet-connected device.
Transparent
The code that controls the operation of the service is transparent to everyone on the blockchain, which enables users to verify and/or audit the service at will.
User-centric
Incentive models reward the user for participating in the service (e.g. providing liquidity for lending), and users can choose whether they access the service through their own custom interface or a publicly hosted one.
Interoperable
DeFi services are natively interoperable with one another due to the shared blockchain network on which they reside; cross-blockchain interoperability networks will further reinforce this phenomenon as they are adopted.
Composable
With broad interoperability, a variety of unique DeFi protocols and services can be used in tandem to enhance the experience or as building blocks to compose net-new applications that offer more value to users.