Decentralized alternative to traditional finance: how DeFi is changing the financial world

Why the traditional system is no longer sufficient?

Imagine: 1.7 billion people on the planet do not have access to bank accounts. They cannot take out loans, cannot save, cannot earn interest on their money. At the same time, those with access to banks are constantly dependent on centralized institutions that control every transaction. History is full of examples of financial crises where billions of people lost their savings due to centralized negligence.

This is where the decentralized financial system comes into play. DeFi is not just a new term; it’s a revolution in how people can interact with money without intermediaries. At its peak popularity in December 2021, the total value locked (TVL) in DeFi protocols exceeded $256 billion, demonstrating huge demand for such solutions.

How does a decentralized financial ecosystem work?

DeFi is built on the foundation of blockchain technology and smart contracts. Instead of trusting a bank to manage your money, you use code — smart contracts that execute agreements automatically when certain conditions are met.

The backbone of this ecosystem is Ethereum, which introduced the Ethereum Virtual Machine (EVM) — a computational engine that allows developers to write smart contracts in programming languages like Solidity. That’s why Ethereum became the second-largest cryptocurrency network after Bitcoin.

However, Ethereum is not the only platform. Solana, Cardano, Polkadot, TRON, EOS, and Cosmos also offer the ability to deploy smart contracts, each with unique architecture and scalability advantages. Despite this, Ethereum remains the dominant platform: out of 202 DeFi projects, 178 are located on Ethereum.

The three pillars on which DeFi stands

The entire DeFi world is built on three financial primitives — building blocks that create new possibilities.

Decentralized exchanges: trading without control

DEXs allow exchanging crypto assets without the need for KYC verification or worrying about geographical restrictions. Instead of a traditional order book model, most DEXs use liquidity pools — users deposit two coins into a pool, and an algorithm automatically determines the price. Today, all DEXs have over $26 billion in locked value.

Stablecoins: digital dollar

Stablecoins solve the volatility problem of cryptocurrencies. They are pegged to real assets — fiat currencies (like USDT, USDC, BUSD), commodities (like gold, silver), other crypto assets, or even algorithms. Over five years, the market capitalization of stablecoins reached $146 billion. The uniqueness of these assets lies in their independence from a single blockchain — one stablecoin can exist on Ethereum, TRON, OMNI simultaneously.

Credit markets: loans without documents

This is the most developed segment of DeFi. Over $38 billion is locked in lending protocols, accounting for nearly 50% of the total TVL in DeFi at $89.12 billion (as of May 2023). Unlike banks, you only need two things: sufficient collateral and a wallet address. No documents, no credit checks, no weeks of waiting.

Where DeFi surpasses traditional finance

Transparency without secrets. Every operation in DeFi is recorded on the blockchain and visible to everyone. No hidden fees, no opaque governance algorithms, no hidden costs. Unlike banks, where interest rate algorithms remain a trade secret.

Speed of the world. An international transfer via DeFi takes minutes instead of days. No need for interbank communication, no regulatory delays in each country, no intermediaries slowing down the process.

Control over your ownership. You have a private key — you have full control. The bank cannot block your account, the government cannot freeze assets, hackers cannot steal money from a centralized bank because there is no centralized storage for attacks.

Continuous operation. Traditional markets close at 5:00 PM New York time. DeFi operates 24/7/365 — liquidity is constant, opportunities are available anytime.

Privacy by design. Smart contracts store data in a secure form, preventing manipulation by malicious employees or external hackers.

How to earn in the decentralized world

DeFi opens new ways to generate income from your crypto assets:

Staking — hold cryptocurrencies that use the Proof of Stake mechanism and earn rewards, as if your deposit were on a savings account, but without a bank.

Yield farming — place your assets in liquidity pools on DEXs and earn trading fees plus rewards from the protocol. Automated market makers (AMM) do all the heavy lifting.

Liquidity mining — provide liquidity and receive liquidity provider tokens (LP) or governance tokens. This is more flexible than farming.

Crowdfunding — fund new DeFi projects in exchange for tokens or a share of future profits. This democratized startup financing.

Where danger lurks

However, no one talks about a bed of roses. DeFi is still a young ecosystem, full of risks.

Code vulnerabilities. Smart contracts have bugs. According to Hacken, hacker attacks on DeFi led to losses of over $4.75 billion in 2022 alone — almost 60% more than in 2021. When a hacker finds a flaw in the code, the money disappears forever.

Fraud and pump-and-dump schemes. Anonymity means anyone can launch a fraudulent project. Rug pulls, pump-and-dump schemes, pyramids — all flourish in DeFi, scaring institutional investors.

Impermanent loss. When you place two tokens in a liquidity pool, and one suddenly rises in price while the other falls, you can lose. Even if the average value has increased. This is a high-volatility crypto market problem.

Leverage. Some platforms offer up to 100x leverage. Attractive for those seeking big bets, but in a volatile market, it’s a path to bankruptcy within hours.

Token risk. Investors often hastily buy new tokens without research. The result — huge losses on projects without reputation or support.

Regulatory uncertainty. Regulators still don’t understand how to control DeFi. If your deposit disappears due to fraud, there’s nowhere to complain — no insurance, no compensation.

What the future holds for decentralized finance

The DeFi sector has grown from a few experiments to a global alternative financial system. It’s an open, transparent, borderless, and censorship-free system. More complex products — derivatives, asset management, insurance — are already being developed.

Ethereum continues to dominate due to network effects. However, Solana, Cardano, Polkadot, and other platforms are gradually attracting developers. ETH 2.0 updates promise to change much through sharding and Proof-of-Stake.

Competition between platforms will intensify. But regardless of the winner, one thing is clear: decentralized finance is not the past. It’s the future that is just beginning. DeFi has the potential to make financial products accessible to billions of people currently excluded from the traditional system. The question is not whether DeFi will be the future, but when it will happen.