Can Decentralized Finance be the Solution for a Financial System that is More Inclusive?

The conventional financial system has repeatedly disappointed us, with events like the Dot Com Bubble and the Subprime Mortgage Crisis. This is not surprising, considering that the system was designed to cater to the whims of the elite traders, whose actions determine the fate of smaller traders. Although checks and balances have been implemented to mitigate the system’s volatile swings, we have witnessed that they are not sufficient. After all, humans are fallible beings.

Blockchain and cryptocurrencies, such as Bitcoin, emerged as a promising alternative to conventional finance between 2017 and 2018. They offered the potential for a new approach to money and transactions, characterized by transparency and immutability. However, crypto also faced the same shortcomings as Wall Street, the very institution it aimed to disrupt.

In 2020, a new concept emerged that combines mainstream financial services with the immutability of blockchain and the objectivity provided by machine learning data. This concept, known as decentralized finance or DeFi, seeks to democratize the financial market without succumbing to the speculative nature that plagued the ICO markets of 2018. Through the use of AI, big data, and smart contracts, DeFi firms are reviving the vision of crypto pioneers who envisioned a transformation in our financial systems.

Similar to all new ideas, enthusiasm is high when the concept is first introduced, especially when it challenges the status quo. This was evident during the ICO boom of 2017 and 2018 when cryptocurrencies became the buzzword for challenging the inefficiencies of the modern financial system. Numerous crypto startups emerged during this time, offering a wide range of services from peer-to-peer lending to virtual pet ownership. The value proposition was clear: the possibility of profiting from investments without the involvement of intermediaries. Crypto showed immense potential during this period.

However, the crash in late 2018 changed the landscape. Users lost interest, investors failed to see significant returns, and regulators stepped in. Some attributed the downfall to the volatility of cryptocurrencies, while others pointed to the low trading volumes, particularly in Asia. Various analysts provided different explanations, but the underlying theme was the general lack of understanding among investors, users, and regulators. Crypto’s enigmatic nature hindered its growth.

Although crypto has somewhat recovered since the crash, the emergence of DeFi raises questions about the possibility of another bubble like the one in 2017. The community is now transitioning from a speculative crypto market driven solely by market forces to a market managed by more sophisticated tools like AI and smart contracts. According to Renato Barba, the Chief Information Officer of MachinaTrader, a company specializing in AI for crypto trading, this transition does not imply another bubble.

Barba emphasizes that unlike during the ICO bubble, DeFi projects undergo external code audits to validate the legitimacy of their smart contracts. This provides assurance to users and investors, reducing the risk of falling victim to dysfunctional or fraudulent schemes.

While DeFi utilizes the same distributed ledger technology as most crypto projects from the 2017-2018 boom, proponents argue that DeFi operates fundamentally differently. This distinction is crucial, given its aim to provide alternatives to mainstream non-crypto financial service providers and speculative platforms within the crypto sector. The key difference lies in the use of AI and smart contracts, which create a more secure way of conducting transactions while ensuring transparency for users. This was an obstacle that initially hindered the adoption of crypto by the general public.

However, this sophistication also poses a risk of relegating DeFi to another fad in the crypto sector. Barba acknowledges that as the market matures, users need to better understand the technical aspects of using a legitimate DeFi platform.

For DeFi to truly democratize the financial system, stakeholders must strike a balance between making the technology accessible to all users and preserving the sophistication that sets it apart from the overly hyped “solutions” of the crypto boom.

Undoubtedly, DeFi offers similar promises to those of the initial crypto projects, particularly in terms of providing better alternatives for accessing financial services. However, as a young sector, it must confront the challenges it faces in order to realize the vision of the crypto pioneers for a democratized financial system. Crucially, it must make its platforms accessible to the general public, ensuring that the processes and benefits of DeFi are understandable and familiar, much like the ubiquity of the internet. This is essential not only for users but also for cautious actors like investors and regulators, whose decisions will be influenced by their understanding of the technology. Therefore, the DeFi sector must engage with stakeholders to raise awareness and provide insight into the merits of the technology.

Lastly, the DeFi sector must capitalize on the trust it promises its users, as trust in blockchain technology as a whole has diminished following the crypto crash. Trust-building measures must be defined and the ongoing hype that attracts bad actors must be overcome to ensure the emergence of this promising technology.

DeFi may truly be the solution to democratizing the financial system that has repeatedly failed us. However, it must overcome the challenges that ICOs in 2018 could not, or else it will become nothing more than a fleeting vision.