The Biggest Problems Challenging DeFi, and How To Solve Them For DeFi to go mainstream, it needs to look outside of Ethereum for scalability & low fees.
By James Murphy Edited by Michael Dolan
Opinions expressed by Entrepreneur contributors are their own.
The prevalent economic narrative of this year has revolved around one concept: inflation. Year after year, hard-earned dollars sleeping in bank accounts are steadily losing value. This phenomenon has been exacerbated during the covid crisis as governments around the world print more money to save many businesses and individuals from bankruptcy. One of the most extensive stimulus plans has been put in place in March by the Biden administration. This historic legislation distributing $1.9 trillion will be funded by the Federal Reserve through the printing of new money.
The banks of the future are on the blockchain
In the face of such inflation, almost all financial assets have seen appreciation since March 2020 with the S&P hitting its all-time-high in March. That growth is made even more impressive by the current economic climate, hard hit by Covid. But the financial sector that has seen the most explosive growth since March 2020 is, without a doubt, cryptocurrencies.
Cryptocurrencies have many uses. It's most famous representative, Bitcoin, has seen exponential growth in these last few months as it is increasingly seen as a safe-haven asset against inflation due to its supply cap at 21 million individual Bitcoin. Bitcoin has seen increased interest as a store of value in a world where all fiat currencies can and will endlessly suffer inflation and long-term holders are still accumulating, delighted with their profits.
But crypto is more than Bitcoin, and institutions are starting to notice. In a recent report on cryptocurrency, Bank of America wrote that decentralized finance (DeFi) was potentially more disruptive than Bitcoin itself.
So, what is DeFi exactly? What does the bank of the future look like?
Read also: How Covid- 19 Has Brought Global Financial Inflation.
Understanding DeFi, the future of finance
DeFi aims to offer financial services to everyone with a smartphone and an internet connection. It's as simple as that. No discrimination, low fees, user-friendly and open-source. Easier said than done though.
Through decentralized apps, apps who live on the blockchain, and smart contracts that allow complex financial operations between users; DeFi apps such as Compound, Aave, Curve or Yearn now allow users to lock their funds in their smart contracts. They can then lend, borrow or simply let their funds accrue value through different financial mechanisms. You can visit some of these websites to see that APYs often range from 5% to 50% on an annual basis, depending on the underlying assets.
These numbers are almost frightening. Admittedly, they are terrifying to the traditional financial system who will simply never be able to create such yields. Decentralized finance is extremely liquid, very composable, and completely digital, decreasing running costs to a few cents. Once a development team has built a product, they don't need to build agencies around the world or allocate a marketing budget. Users get the best rewards for their money because middlemen are essentially eliminated from the equation.
But DeFi has been a victim of its own success. Today, almost all DeFi transactions take place on the Ethereum blockchain. Each of these transactions cost a certain amount of ETH, Ethereum's native cryptocurrency, to settle on the blockchain. Due to the rising popularity of DeFi in 2020, the costs of transactions have strongly increased in the last few months meaning simple transactions can cost up to $20 and complicated interactions with smart contracts up to $200 depending on the current usage of the blockchain.
Additionally, DeFi is very complex to use. The user experience is notoriously complex and understanding how to interact with different DeFi protocols is not a skill everyone can master. This leads many industry insiders to believe we haven't seen the eventual global-adoption ready DeFi protocol.
Read also: How 2020 Became the Year of DeFi and What's to Come in 2021.
Scaling DeFi
Right now, DeFi is running into a wall that it could never avoid: scalability. Blockchain technology requires every transaction to be made publicly and registered on the blockchain. This limits the number of transactions that can ever be made at any time. This guarantees the security of the network but comes at a cost. After careful analysis, a project has shown great promises and answers to the two main challenges of DeFi: accessibility and scalability.
Relite Finance is a cross-chain lending project built on Polkadot. Polkadot is separate blockchain than Ethereum but it has interoperability built-in allowing cross-chain transfers of any data or an asset. This access is of paramount importance as a vast majority of the users and capital in DeFi are using the Ethereum blockchain. By using the Polkadot blockchain and allowing seamless communication with Ethereum, Relite essentially resolves the issue of scalability.
The future of DeFi has to be on multiple blockchains and the projects built to be adaptable will have an advantage in such a fast-moving environment. Interoperability in decentralized finance can be linked to interoperability between computer operating systems. By building apps that work on Mac, Windows, iOS, Android or Linux, companies ensure they have access to the greatest number of potential users. Even if the overall cost of development is increased, it's a very worthwhile investment.
An apt metaphor for building on Polkadot is an imaginary highway with constant very high traffic. What Relite is doing is building their financial services on another parallel highway that regularly offers access to the first highway. The main advantage of this strategy is reducing the fees for users. While on Compound or Aave users would pay $50 to $100 for transactions, on Polkadot these will be available for a fraction of a cent.
Relite tackles the last issue of DeFi as a whole, its complexity. The goal is to provide a decentralized application that can be widely used by everyday people for lending and borrowing without much complexity. The first challenge of this ambition is reducing the fees one has to pay to take part in DeFi but the second challenge is making it easy to understand and to use. Looking at the UI of Relite, it is clear that simplicity has been the foremost priority for lending and borrowing across blockchains.
Decentralizing finance is, above all, about bringing equal opportunities to billion-dollar funds and regular humans. Right now, the majority of the world is losing money in an economical landscape dominated by inflation. But it doesn't have to be this way, the reinvention of the financial sector is already happening, one click at a time.
Read also: 4 Ways DeFi Can Generate Passive Income.
