DeFi: the escape route from TradFi

How does DeFi differ from TradFi (traditional finance) and what is the difference for the user?

DeFi (decentralized finance) aims to disrupt the finance market by cutting out the middleman, for example, your bank. It focuses on borrowing, lending an market making and allows investors to directly interact with each other on a peer-to-peer (P2P) basis by providing loans or liquidity for trading and assume those roles/functions in return for generating fees. Marc Bernegger,  tech entrepreneur and AltAlpha Digital crypto hedge fund co-founder, describes what has happened, “The disruption of the banking sector, which we have seen in the recent years driven by FinTech players, has now escalated to the next level with DeFi laying the groundwork for a peer-to-peer ecosystem.” 

There are four ‘tools’ that have enabled DeFi to grow. They are:

  • Artificial intelligence
  • Big data
  • Cloud
  • Distributed ledger technology (smart contracts & blockchain)

What is the problem with TradFi?

The TradFi space, while well established, presents some significant barriers to entry for portions of the population. For example, in emerging economies there are large portions of the population (50-70%) that have no access to banking.

By contrast, DeFi is a digital assets space that can be accessed 24/7/365, with services and global network coverage being constantly expanded and improved. Its accessibility has drastically increased with the spread of Internet coverage and cheap smartphones in all economies.

However, while DeFi sounds great in theory and has been shown to work in practice, there is still a long way to go. The topic remains complex and hard to grasp for many potential users. User interfaces and processes still have plenty of room for improvement and simplification, fees can vary, resulting in unreasonably high charges for smaller transaction amounts.

How you can make money with DeFi

There are two ways: you can either invest in the DeFi projects/protocols by buying the respective tokens while expecting capital gains through price increase based on a superior platform offering, user and asset growth. Or, you can actually use these platforms as an “operator” and generate income from the various activities available. These are:

  • Staking
  • Lending
  • Liquidity provision
  • Yield farming

What you should look for in a DeFi project

When doing your due diligence on any DeFi platform, the key things to look at are:

  • Team
  • Technical
  • Tokenomics
  • Insurance
  • Pools

This is a new industry that is growing in front of us, and while it still has to mature, it is changing the face of finance, especially if you want to obtain a loan, or want to make money by lending yours. No TradFi service offers you this with such ease.

Why the world needs DeFi

One of the compelling reasons the world needs decentralized finance (DeFi) is the corruption in the financial system. I have just been reading an opinion piece by RTR Crypto in Cointelegraph, which highlights the issue of remittances. Around the world there are a considerable number of people who work in another country in order to send money home. This is a finance sector known as ‘remittances’. The issue for these people is that those companies known as ‘remittance providers’ take a chunk of the workers’ hard earned money, and it could be as much as ten percent, or even 20%.

When migrants send home part of their earnings in the form of remittances, they represent a large source of foreign income for many developing economies. They can represent as much as 4% of the GDP in a low-income country, and 1.5% for middle-income countries. Furthermore, remittances are important because they tend to be stable, and instead of decreasing during economic downturns or after a natural disaster. They actually increase, while private capital in-flows decline at these times.

DeFi solves the remittance pain

As RTR points out, credit card companies and personal loan services charge high fees, as do remittance services. By contrast, a DeFi platform could radically cut the fees workers pay to send money to their home country. Workers pay the high fees because they have no choice – their families depend on this money to keep them out of poverty. The amount sent annually is in the hundreds of billions of dollars, which makes it an appealing sector for DeFi platforms.

DeFi platforms offer everyone, not just the world’s migrant workers, a way to have greater control of their money. In addition to paying much lower transfer fees, users would have access to borrowing, lending, trading on margin and so much more. Plus, DeFi coupled with stablecoins is a powerful combination, especially for the unbanked. And those who receive the remittances can also take advantage of the products offered by DeFi, such as reward systems like liquidity pools or staking. It’s a win-win solution – and that is why the world needs DeFi.

DeFi’s road to mass adoption

According to Eric Chen, CEO and co-founder of Injective Labs, while the DeFi sector has witnessed massive growth since 2020, there are still some issue to address, namely scalability, gas fees and liquidity. On the upside of this remark, Chen also noted that the entire DeFi industry is focused on building infrastructures to address these problems, saying: “It still has a lot of problems to solve before being able to serve billions of users. Scalability, miner extractable value and gas costs will become more and more important to improve over time.”


It is also good news that the total value locked (TVL) in decentralized finance (DeFi) has risen above the $200 billion zone after slipping below that range for most of the year. In January the TVL had dropped to a low of $185.20 billion, but jumped by 13.54% to reach over $200 billion on 20th March.

It has also been noted that new forms of utility like liquid staking are on the rise and some believe that more people may be drawn to DeFi as more institutions jump into the fray.

Chen believes that the sector’s growth can be attributed to the development of new primitives and user growth, and commented, “With many traditional institutions joining the space, DeFi will gradually reach mass adoption.” 

Permissioned DeFi

One of the reasons traditional institutions may enter DeFi is Permissioned DeFi, a form of DeFi that combines decentralization with centralized mechanisms like whitelisting for Know Your Customer and Anti-Money Laundering purposes/ He said, “Permissioned DeFi certainly allows traditional institutions to be much more comfortable in participating in the ecosystem. It will play an important role in fostering global mainstream adoption.”

For example, this year, liquidity protocol Aave launched a permissioned deFi pool. This allows institutions to access decentralized finance features while being compliant with existing regulations. 

DeFi is easier to regulate

Chen also commented that DeFi is easier to regulate than legacy infrastructures. He believes that DeFi’s mission to “provide decentralized, secure, and transparent financial services,” makes the work of regulators much easier, providing they do proper research into it, and understand it.

Layer 1s versus Ethereum

Last year, the networks that set out to compete with Ethereum for a slice of decentralized applications proved to be profitable. These blockchain networks, also known as ‘Layer 1s’, include Solana, Polygon, Avalanche, Polkadot and Cosmos amongst others.

These protocols are masters of decentralized computation, something that can power any type of software, but is “particularly apt for digital scarcity, property rights and provenance,” writes Lex Sokolin at Coindesk. And as last year showed, they proved to be increasingly profitable for investors. However, they only remain valuable if they are used by the developers who make apps.

They also require users. As Sokolin says, “if there are users in your platform, developers value that as a distribution channel in addition to a technology enabler.” He refers to this creating a viral loop “that can create positive network effects, which allow certain equilibria to hold, and others to collapse.” He adds, “So layer 1s do both – they provide the computational unit as well as the market context in which that computational unit is generated and executed.”

Yet Ethereum is still holding the biggest slice of the market. It is true that its dominance has declined. For example, in September 2020, Ethereum had 90% of the assets on the market, and today it has about 50%. How and why has that happened?

Let’s take Avalanche as an example. It is launching a $290 million incentive program to grow the applications built on its technology. Its market cap is around $30 billion, so this expenditure on platform growth and customer acquisition is only one percent of its cap. And last year, Polygon, targeted DeFi growth with a $100 million ecosystem fund, which worked for it, as you will find quite a number of DeFi projects on its blockchain.

Ethereum by contrast was boosted by Consensys, which “played the role of ecosystem fund in the early days, eventually generating sufficient building and adoption by the community.”

These ecosystem funds are a really important element in the rise of Layer 1 solutions. Success and sustainability comes from spending on marketing, growing your adoption against others, building in profitability and using profitability to grow your market share. Ultimately, it should have been easy for Ethereum to hold onto the lion’s share of the market, but it didn’t factor in investors’ appetite for. As Sokolin says, “there’s a lot more risk capital out there wanting to recreate a layer 1 investment return profile,” which is good news for those protocols.