With the launch of Ethereum 2.0 approaching and Ethereum’s recent fifth anniversary, it is only fitting that our Blockchain, Cryptocurrency and Digital assets team look at the biggest topic in the blockchain space at the moment: Decentralized Finance, or DeFi. In simple terms, DeFi is a financial ecosystem of decentralized applications (DApps) built on the Ethereum blockchain network. Originally termed “open finance”, the DeFi system is independent from the centralized, legacy financial system. Although in its early stages, DeFi already has $4 billion of value locked in it. In this article we consider what it means to have globally accessible, permissionless and trustless financial services available at the scroll of a finger without any centralized, intermediary involvement.
What can be done with DeFi?
The possibilities are virtually endless. There might be a time when every financial service currently offered by institutions is adapted for the cryptosphere, although it may take a while before laws and regulations adapt. The most popular current examples of DeFi include:
Why is DeFi so revolutionary?
As with any computer code however, smart contracts are not always invincible. Some DApps are still in beta testnet mode and are not (yet) insurable against cyberattacks or programming errors.
Yield Farming & Liquidity Mining
Any exploration of DeFi cannot ignore the current buzz around two new DeFi concepts, “yield farming” and “liquidity mining”. Yield farming describes earning a return on capital by lending crypto assets out on DeFi protocols such as Compound or Aave. Users providing liquidity earn interest and other rewards as a result. The “farmer” might also receive a new token in exchange for providing that liquidity, hence ‘liquidity mining’. Token holders are granted governance rights over the protocol and ultimately receive a percentage of protocol fees.
Both concepts seem to be largely responsible for the recent surge of interest in DeFi. However, some commentators are urging caution regarding the long-term sustainability of investors ‘yield chasing’ which has fuelled recent DeFi token price growth.
The future of DeFi
DeFi is still a long way from the mainstream but undoubtedly has the potential to replace, even if only partly, centralized financial infrastructures and shift power to individual users and investors. Not every use case will benefit from decentralization and only time will tell how successful the DeFi revolution will be. In the meantime, watch this space and join the growing London DeFi Network, chaired by our Senior Associate, Allan Murray.
If you have any questions about DeFi regulation or if you require any legal assistance, contentious and/or transactional, in the field of blockchain, cryptocurrencies, smart contracts or digital assets, please contact our Senior Associate, Allan Murray via email at email@example.com or our Trainee Solicitor, Mariya Lazarova at firstname.lastname@example.org. None of the above constitutes financial advice.