DeFi's Impact on Financial Markets: An In-Depth Analysis of Decentralised Finance

Analysis of DeFi (decentralised finance) and its impact on financial markets: Overview of key DeFi projects and their potential to transform traditional financial systems

DeFi trends exist inextricably linked to trends in blockchain technology and the cryptocurrency market. According to analysts, after last year’s recovery period, the cryptocurrency, blockchain and Defi markets are expected to take off. The laws of market cyclicality and the prevailing market trends predict the rapid development of decentralized financial systems in 2024.

Let’s take a look at what DeFi and the blockchain economy are all about, the extent of DeFi’s impact on traditional finance, and what the future may hold for the DeFi market sector and its related products.

The concept of DeFi

DeFi (decentralized finance) is a sector of the cryptocurrency market that uses blockchain technology to provide financial services as an alternative to the traditional financial systеm. Transactions in DeFi are completely anonymous and do not require the involvement of an intermediary, as they are conducted through protocols that connect users directly to each other. Anyone using the internet can interact with the ecosystem and manage assets.

Decentralized systems eliminate the need for centralized management structures, as all the rules of transactions are defined in smart contracts. All that is required is to launch the contract, and then the DeFi application works independently or with minimal user involvement. Decentralized solutions accelerate the financial transaction process, eliminate a single point of failure, and reduce associated costs.

DeFi vs CeFi

The main goal of decentralized finance is to become an alternative to the traditional centralized financial systеm (CeFi), where third parties control all financial assets and transactions, while DeFi creates an ecosystem where participants can interact directly. In 2023, three times more venture capital funds were channeled into DeFi than into the traditional CeFi market (18% and 6%, respectively), indicating high investment expectations for the sector going forward.

DeFi and traditional finance share some similarities and distinct differences.

Key similarities between DeFi and CeFi:

List of core financial services (deposit programs/staking, credit, loans, trading).

Dependence on supply and demand.

Perhaps this is where the “similarities” end and the differences emerge, which allow the DeFi segment to successfully compete with traditional financial systems:

CeFi depends on centralized organizations (financial regulators, banks, and other financial service providers). DeFi, on the other hand, operates without intermediaries, which reduces project costs and, consequently, commissions and entry thresholds.

Thanks to blockchain technology, DeFi provides transparency by allowing users to verify transactions and the fulfillment of smart contracts themselves.

Decentralized finance is a malleable and agile ecosystem. DeFi projects and innovation in the technology market go hand in hand and can evolve rapidly, constantly introducing new ideas. CeFi, on the other hand, is burdened by a complex systеm of governance and regulation.

In traditional finance, anonymity is unacceptable. Customers must prove their identity with documents to open an account, make a deposit, or take out a loan.

Decentralized finance eliminates bureaucracy and visits to public places, thus saving significant time.

DeFi allows access to the necessary financial instruments without restrictions on age, citizenship, or geography.

DeFi’s history of existence and its development in 2023

2017-2018. It is this period that can be considered the beginning of the development of the sector. According to experts, the birth of the market occurred when the MakerDAO team launched the cryptocurrency-backed DAI algorithmic stablecoin. This was one of the key technological events of 2017. By the way, as of mid-2023, the capitalization of DAI was $4.7 billion (it was surpassed only by USDT and USDC).

2019. Compound and MakerDAO projects sharply increased frozen funds metrics. Innovation in DeFi started to boom. Scaling protocols (Lightning Network and Raiden Network) were actively used. The concept of decentralized exchanges (DEX) emerged. By the beginning of 2020, more than $1 billion of assets had already been placed on DeFi platforms (three times more than in January 2019).

2020. Starting this year, the cryptocurrency world experienced a DeFi boom. The popularity of decentralized financial applications and protocols grows exponentially. DeFi projects expand the list of provided options (staking, loans, cryptocurrency exchange). The tool of yield farming (earning income in native tokens through some form of interaction with DeFi protocols) develops. TVL (Total Value Locked) jumped to $19.4 billion this year. The development of decentralized financial applications generated significant interest in stable and functional assets.

2021. The sector experienced rapid growth on all fronts, with TVL exceeding $250 billion by the end of the year. Hackers and fraudsters also became active, and 2021 was marked by record hacks and huge amounts of stolen funds. About $1.7 billion was stolen from DeFi protocols, more than $7 billion through fraudulent schemes, and approximately $3.1 billion through hacks and hacker attacks. At the same time, the rapidly growing market has also attracted the close attention of regulators. As a result, the ecosystem community focused on cybersecurity and regulatory issues throughout the year.

2022. Stablecoins have become a major DeFi instrument and are widely used for payments, loans, and credit. The average transaction size has decreased slightly, indicating investors’ caution caused by economic uncertainty and regulatory risks. As a result, investment in DeFi has been made predominantly with stable coins.

2023. The sector shows strong growth and is in anticipation of the start of crypto spring 2024.

Data on the inflow of funds to the crypto market due to DeFi by TVL. Sources: CoinMarketCap and Ukraine Economic Outlook:

Year	2018	2019	2020	2021	2022	2023 (first half of the year)
Value locked inDeFi (TVL)	0,0	0,6	19,8	310,1	68,9	89,1

Use of DeFi’s main instruments

Lending and borrowing

The lending and borrowing procedure in the DeFi world is much simplified compared to the traditional one. With collateral, everyone has access to capital by participating in liquidity pools. Examples inсlude Aave and Compound, where liquidity providers contribute assets to a pool and receive a fee, and borrowers borrow from that pool and pay interest.

Insurance

The systеm operates on the principles of a traditional systеm, and its purpose is to protect the user from losses they may incur as a result of a smart contract vulnerability or hacker attack.

Earnings from GameFi

Platforms such as Axie Infinity and The Sandbox, which combine DeFi, NFT, game tools, and smart contracts, allow users to earn rewards and utilize resources in the in-game economy using blockchain technology.

Trading on Decentralized Exchanges (DEX)

DEXs allow you to trade cryptocurrencies without intermediaries, conducting transactions directly between accounts. They do not require registration and verification, only wallet synchronization with a smart contract is needed.

The role of Ethereum

Ethereum continues to lead the way in terms of the number of DeFi projects deployed on the blockchain. It was the Ethereum team that pioneered the smart contract revolution by creating the first protocol running on this technology. According to DeFi Llama, in 2023 TVL in Ethereum-based DeFi projects exceeded $30 billion (more than 50% of the total in the sector). At the same time, Ethereum is experiencing certain difficulties with scalability and lower transaction fees. Therefore, alternative networks such as NEAR, Avalanche, Tron, Solana, or Arbitrum are gaining popularity.

The future of decentralized finance

The growth dynamics of the DeFi markets and the trends we can observe show us that decentralized finance will become an integral part of the global economy in the near future. The market expects DeFi to simplify transactions even more; many countries (including Ukraine) are preparing to issue digital currencies; DeFi-based payment gateways already perform transactions in seconds. DeFi 2.0 is under active development and real-world asset (RWA) tokenization is gaining momentum.

Of course, regulatory pressures and the risks of fraud and hacker attacks must be addressed for the industry to evolve further. However, the risks and opportunities of DeFi are not comparable.

Most analysts predict a strong influx of funds through the institutional adoption of cryptocurrencies for portfolio management following the approval of spot ETFs and bitcoin halving. Either way, markets are cyclical by nature, and the crypto spring is just around the corner. That means we can expect the decentralized finance market to surge in the coming months.

Thank you for your attention!

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