Decentralized Finance is an ecosystem of financial applications and protocols that runs on blockchain technology. Blockchain technology is inherently decentralized in nature. DeFi financial applications leverage this aspect and run without relying on intermediaries like banks, brokers or exchanges. Moreover, the backbone of all DeFi protocols and applications is smart contracts.

1. DeFi : The Future of Finance
The application of blockchain technology in the world
of finance has created a new landscape called DeFi
or decentralized finance. DeFi has manifested an
astonishing growth in the year 2021 and it is still
burgeoning. It has unleashed a wave of innovation.

2. What exactly is DeFi?
There is no standard definition for Decentralized Finance.
Some say it is an alternative financial infrastructure, some
say it is an umbrella term for peer-to-peer financial systems,
some say it is a competitive marketplace of decentralized
financial applications, and so on.
Decentralized Finance is an ecosystem of financial
applications and protocols that runs on blockchain
technology. Blockchain technology is inherently
decentralized in nature. DeFi financial applications
leverage this aspect and run without relying on
intermediaries like banks, brokers or exchanges. Moreover,
the backbone of all DeFi protocols and applications is
smart contracts.

3. What problems does DeFi solve?
The biggest and the fundamental problem that DeFi solves
is the removal of intermediaries in the financial system.
Harvey et al. in their book Defi and the Future of Finance
describe that DeFi solves five key problems of the current
financial system: centralized control, limited access,
inefficiency, lack of interoperability, and opacity.
Harvey et al. in their book Defi and the Future of Finance
describe that DeFi solves five key problems of the current
financial system: centralized control, limited access,
inefficiency, lack of interoperability, and opacity.

4. The DeFi Market:
DeFi has manifested tremendous growth in the year of
2021. As of January 15, 2022, the total value locked in the
DeFi space was approx $237 billion, growing by a
staggering 1,266% from the January 1, 2021 figure of $18.71
billion.

5. How can DeFi solve your problems?
DeFi solves the problem of lack of transparency in the
traditional finance system through the open and
contractual nature of agreements. Smart contracts helps
to encode the agreements. Anyone can read the smart
contracts codes thereby ensuring transparency. Moreover,
all transactions are publicly visible.
Traditional financial system is trust based and dependent
on centralized institutions. DeFi replaces some of these trust
requirements with smart contracts. The decentralized
blockchain network stores the smart contracts.
Before we delve into each problem, let’s look at the
different layers of the DeFi stack.

7. The settlement layer (Layer 1) consists of the native
protocol of the blockchain network (e.g., ETH, BTC, MATIC).
These native tokens are specific to their blockchain
network, i.e, ETH is on Ethereum network, BTC is on Bitcoin
network, and so on.
The asset layer (Layer 2) consists of all the assets issued on
top of the settlement layer. These assets are usually
referred to as tokens (e.g., ERC-20 based DAI token in
Ethereum). Developing smart contracts that follow EIP
standards like ERC-20, ERC721, ERC1155 helps to create
tokens.
The protocol layer (Layer 3) contains the smart contract-
based protocol implementation for different use cases
such as decentralized exchanges (DEX), lending,
derivatives, on-chain asset management, and so forth.
The application layer (Layer 4) consists of end-user
applications which are accessible via web browsers or
mobile apps.

8. Layer 5 is the aggregation layer that combines several protocols
and applications and provides services like rate comparison,
trading strategies, and so forth (e.g., 1inch, Zapper, Zerion).
DeFi solves the problem of limited access by allowing the
creation of an open and accessible financial system. It enables
direct access to financial services for the globally unbanked
population. As a result, it allows access to all users irrespective
of their wealth or geographic location.
DeFi in the current world:
Trading today is extremely centralized in the traditional finance
world. Five exchanges control 50% of the volume of all stocks. In
a traditional exchange like the New York Stock Exchange buyers
and sellers offer up different prices until they come to an
agreement on a sale price. Only a small subset of the traditional
finance world has access to the full order book of prices, limiting
price discovery for everyday users. However, there is a limit on
the liquidity for certain securities. DeFi solves these problems with
an innovation called automated market makers (AMM).

9. Decentralized Exchanges use an automated market maker
(AMM) for automated trading. AMMs is essentially an exchange
which helps to swap one cryptocurrency for another. The
liquidity pool maintains a particular exchange rate, for example
10 ETH to 1 BTC. This is a pool with a variable exchange rate
between two currencies. The AMM facilitates a price for
transactions based on the supply, demand and liquidity in a
pool. The investors in the pool put money into it to earn a yield.
Some of the popular decentralized exchanges are Curve
Finance, Uniswap, PancakeSwap, and SushiSwap.
Traditional finance institutions tend to work in silos and maintain
their own ledgers. Hence one financial service may not be
interoperable with another. DeFi is built on public blockchains
and open standards. This allows for interoperability across
different decentralized apps (or dapps). However, there is a limit
on the interoperability to the same blockchain network. As a
result, there are lots of initiatives in progress that focus on
enabling cross-chain communication across different
blockchain networks.

10. Final Thoughts:
FinTech has been trending over the past few years. Many
FinTech startups have been harnessing innovation and
using technology to improve the delivery of financial
services. Fintech companies use technology to create
better financial services to customers and other businesses.
They include big data, AI/ML, automated CRM, robo
advising, personal finance, insuretech, payments, lending
platforms, and so on. However, one main difference
between FinTech and DeFi is that most of the FinTech
solutions are centralized; however all DeFi platforms are
decentralized.
Defi not only addresses the drawbacks of the centralized
finance systems but also has paved the way to many
innovative financial instruments such as atomic swaps,
autonomous liquidity pools, decentralized stablecoins, flash
loans, among others. In short, DeFi has a lot of potential
and can play a pivotal role in the future of finance.

11. Like other businesses, if you too are looking to develop IT
Solutions in Financial Services industry, Mindfire Solutions
can be your partner of choice. We have gained significant
experience over the years working with Fintech
Companies. We have a team of highly skilled and certified
software professionals, who have developed many custom
solutions for our global clients over the years.

12. Contact Sales
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