Decentralized finance, sometimes known as DeFi, is a rapidly expanding sector of the financial markets. DeFi delivers software services based on a blockchain platform that can eliminate intermediaries in financial transactions, allowing financial services such as mortgages and investments to be supplied at cheaper costs. The question is whether it will take off or whether the financial sector will oppose it.
This article delves at how DeFi strengthens traditional financial markets, increases financial inclusion, boosts traditional financial service innovation, and whether regulators should create new legal frameworks for it.
The 2008 Global Financial Crisis (GFC) and the COVID-19 pandemic highlight the problems with legacy financial systems and their vulnerability to unforeseen macroeconomic catastrophes. By providing a distributed framework, blockchain innovators believe DeFi will be able to uncover possible systemic financial risks that older capital systems have struggled to identify. The mapping of systemic risk over a single or more interconnected blockchains might be easier with a distributed DeFi ecosystem.
DeFi has a larger number of participants and less friction. According to the World Bank, around 1.7 billion adults worldwide are unbanked. If this is true in one of the world’s most industrialized countries, one can only fathom the vast number of unbanked people in undeveloped countries.
Asset management, payment, derivatives, gaming, insurance, mortgages, and real estate are among the big industries in which DeFi is innovating at scale. Efficiency and price are the major use-cases for these businesses; why have many distinct systems with independent pricing methods when DeFi can house on interconnected blockchains?
DeFi-based applications take the position of financial intermediaries, reducing labour and operational expenses for banks and allowing for lower borrowing and greater lending rates. DeFi has introduced competition to established payment systems and banks, forcing them to innovate due to increased interest rate premiums, cheaper remittance costs, and speed.
Although relevant DeFi regulatory regulations have not yet been fully formed, the topic of DeFi regulation has increased in tandem with DeFi’s expansion. The SEC’s expansion could be hampered by a lack of clear rules, according to seven out of ten senior members. To deal with the red lights raised by DeFi, financial regulators in nations and regions such as the United States, the United Kingdom, and Europe began developing new regulatory laws. Europe, for example, is considering adding DeFi in the Markets in Crypto Assets (MiCA), while the United Kingdom and the United States are experimenting with ‘embedded regulation,’ in which regulatory procedures are included in the architecture of each DeFi initiative.
When rules are completely created, DeFi project developers are more likely to be the ones who bear the legal risk. The good news is that, if crypto crime grows in scale, “DeFi could someday fall under the ambit of global regulators,” according to the US Department of Homeland Security.
Without a doubt, DeFi is altering the traditional financial system and diversifying markets, regardless of your views on resilience, financial inclusion, innovation, or regulation.