How does DeFi help? What are the real problems that DeFi solves? While DeFi, or decentralized finance, has a total valued locked (TVL) of hundreds of billions today, this is still very small. Both the global equity market capitalization and the global bond market outstanding were each worth over $100 trillion in 2021, while the TVL for DeFi DEXs and lending dApps has only reached around $100 billion recently (or 1% of the traditional finance equivalent value). As DeFi continues to grow, let’s talk about some real problems that DeFi solves.
How does DeFi help?
DeFi is a peer-to-peer financial system that utilizes blockchain technology and does not have a central authority. Many of the institutions that we use today such as centralized stock exchanges, insurance, lending/borrowing, or savings accounts can all be done in DeFi. Let’s look at some real problems that DeFi solves.
- Accessibility— When people ask “Does DeFi solve anything?”, we know one of the biggest drivers for the creation of DeFi is removing a central authority. Although the global financial system has increased the economic well-being of many people around the world, governments and corporations have used their control of these systems for their own means. Entities such as governments or corporations have banned or seized the assets of individuals or have placed blanket bans on hundreds of millions of people from other nationalities in political or economic retaliation. Many times, the poor people hurt most by these sanctions haven’t done any illicit actions to warrant this response and are usually hurt the most by these sanctions. DeFi access is decentralized, meaning access can’t be limited by nationality or controlled by any entity. DEXs, lending, insurance, yield optimizers, and many other applications will be available to everyone with no gatekeeper.
- High fees from Centralized Finance — Another problem that DeFi solves is the reduction of economic rent, or the economic wealth obtained through potentially manipulative use of resources with little reciprocal contribution of productivity. Rent seeking is when entities such as businesses, like banks or insurance companies, lobby the government to create barriers of entry for competition or pass legislation to limit their competition. A good example for the United States is the banking system. Many U.S. residents get their salary deposited into checking or savings accounts at banks that offer less than 0.50% APY or less in interest. However, average US inflation from 2009–2021 has been around 2–3% per year. However, banks give out personal, auto, or mortgage loans where the interest rate could be up to 10% or higher using the checking and savings deposit of the resident. In fact, a user could get a 0.50% APY from a bank and could apply for a loan from the same bank and be offered an interest rate 10x higher. DeFi helps solve this problem through dApps like MELD or AAVE, which allow users to lend out their funds and receive the interest payments instead of a bank. The economic rent of the bank is eliminated.
- Transparency— DeFi solves the real problem of transparency. Since DeFi is based on smart contracts, a user can follow in real-time all the transactions that are made on the public blockchain. In addition, many dApps open source their code, which allows anyone to replicate their dApp. The transparency of DeFi, with a reliance on the immutable blockchain and open-source code, creates the trust needed for DeFi’s continued growth.
Conclusion — Does DeFi solve anything?
How does DeFi help? There are real problems that DeFi solves. Removal of centralized authority or gatekeeper, wider accessibility for more individuals, elimination of economic rent, and transparency are all things the centralized finance system we have today lack and where DeFi can be a solution.