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Decentralized Finance (DeFi) has a Total Value Locked (TVL) of about $75 billion, which currently places the industry 42nd when ranked alongside the largest US banks by deposits. 36% of banking executives believe that DeFi provides an opportunity for banks, while another 18% believe that DeFi presents an existential threat to banks. But which is it?
Whether the traditional finance (TradFi) industry sees DeFi as a threat or an opportunity, the fact remains that DeFi is growing in popularity — the number of unique wallets used in DeFi surged to more than 4.5 million at the end of Q1 2022.
Bitcoin kickstarted the cryptocurrency industry, and it has continued to become an important part of DeFi. Today, more than 260,000 wrapped BTC are being used in DeFi applications on Ethereum and other chains. Why is Bitcoin DeFi popular? Let’s take a look at the shared traits between Bitcoin and DeFi that have helped accelerate their popularity.
DeFi technologies enable permissionless transactions for anyone from anywhere in the world without regard to their ethnicity, social status, political affiliation, or any other factor. DeFi is permissionless, which means anyone can use it. DeFi’s openness also leads to a user experience designed around speed and simplicity.
Compared to TradFi where you need to provide a combination of documents (a government-issued ID, utility bills, proof of employment, etc.) to open an account, the account opening process for DeFi applications is significantly more frictionless. All a user needs to do is connect their wallet to a DeFi platform, and they can start trading, saving, lending, borrowing, or carrying out any other financial transactions supported by the platform. That reduced friction aids DeFi’s growing popularity.
The permissionless nature of DeFi goes beyond just accessibility however. In fact, developers can permissionlessly integrate with other DeFi projects or even take another project's code altogether to create new financial products and experiences for the end user.
Bitcoin modeled this concept of “permissionless” first by enabling miners and users to freely join (and leave) a functioning decentralized network. No central authorization is required to read and write transactions on the Bitcoin network, and the network is designed to ensure rational behavior from participants (removing the need for policing). Being permissionless is a core feature of Bitcoin, and Bitcoin DeFi enables developers to explore the full financial possibilities of a permissionless currency.
In DeFi, all information is public. The smart contracts specifying the logic, the transactions between different wallets, and more are all publicly available. With this information, anyone can find data and understand how exactly a DeFi protocol generates X% APY for their deposit if they are willing to look.
This transparency contributes to DeFi’s popularity because it provides a level playing field for all participants. It enables users to conduct due diligence and identify (and avoid) projects engaged in unhealthy business practices and projects that are promising and worth participating in. This rich, transparent data is updated in real time and allows users to audit the blockchain and trace past events, which can be seen in the numerous post-mortems of the recent Luna Crash and in the ability to track hacked funds.
In contrast, information in TradFi is opaque and often in walled or siloed proprietary databases. Users frequently have to make decisions based on incomplete or outdated information.
Bitcoin’s blockchain is designed around transparency. All Bitcoin transactions are immutably stored in a public ledger; and anyone can query the ledger to check the transactions from any wallet address and the balance of any address. That legacy of transparency is continued in Bitcoin DeFi through Clarity smart contracts on the Stacks blockchain (a Bitcoin layer for smart contracts). Through Clarity, the source code of all DeFi smart contracts is available in its human-readable form on the blockchain for users to examine before interacting with any DeFi application.
DeFi enables self-custody of crypto assets, meaning users themselves hold their assets. Self-custody in DeFi contrasts with the custodial nature of TradFi (and CeFi), where users cede control of their assets to centralized intermediaries who then execute transactions on their behalf.
These centralized services can provide important functions, such as securing your assets or providing access to credit. However, they also insert control over your assets: they can limit withdrawals or require approval for payments. And sometimes, that control can lead to bad outcomes for users. For instance, Wells Fargo once charged more than 800,000 customers for unneeded auto insurance; making more than 250,000 customers delinquent after the charges piled up.
Government overreach can also impact these centralized services, such as when the Lebanese central bank limited access to cash withdrawals in 2019. And while it is easy to think that government overreach is only a problem under oppressive regimes, consider that in 2022, the Canadian government froze the bank accounts of hundreds of protesters.
Whether they don’t trust custodians, the government, or simply value independence, many people want self-custody. However, in TradFi, if you did self-custody, it would be akin to keeping your money under a mattress: you wouldn’t be plugged into the financial system and would miss out on many services.
Bitcoin helped pioneer the concept of digital self-custody, and a mantra of “not your keys, not your crypto” has been a rallying cry for self custody ever since. DeFi expands the possibilities of self custody and allows users to not only maintain their independence and self-sovereignty, but to plug into the DeFi financial system and access financial services as needed. The best of both worlds.
Another factor behind DeFi’s growing popularity is how it enables the creation of a unified global market. DeFi removes intermediaries and lowers entry barriers to widen the scope and reach of financial services. DeFi’s ability to welcome users from all over the world without the limitations of nationalities or borders is a key driving force behind its popularity.
In TradFi, many developing economies are excluded from financial services, and international policy influences who can access what service. For example, today more than 80 countries can’t receive money through PayPal, one of the most popular online payment solutions in the world.
Bitcoin elegantly solves that problem. Not only is it a global network that anyone with an internet connection can access and send/receive BTC (goodbye borders), but it is a peer-to-peer network (goodbye bank to bank transfers and additional fees).
DeFi also has a global reach that enables it to stay open 24/7 across time zones. The lack of opening or closing times in the DeFi market allows for more timely transactions because trades can be executed in real time—no more waiting for market hours to open, which can drive greater liquidity and efficient price discovery.
Bitcoin benefits from global brand recognition: in 2021, Bitcoin’s adoption jumped more than 880% across disparate countries, from Vietnam to Afghanistan. It has worldwide renown. Bitcoin DeFi benefits from that brand recognition and from the ability to serve a global market instead of a regional one. As global adoption grows, so do the network effects. Bitcoin DeFi isn't going anywhere anytime soon.
Smart contracts are the foundational pieces for DeFi projects, but vulnerability in smart contract source code can permit malicious actors to exploit DeFi apps: as of today, roughly $3.4 billion has been lost to DeFi exploits.
One way to reduce the vulnerability of DeFi applications is to ensure that the smart contract programming language used in them is engineered with a focus on security. Clarity helps developers write more secure smart contracts for the Stacks blockchain, which is anchored to Bitcoin. Bitcoin has been battle-tested and remains unhacked, and Bitcoin DeFi technologies inherit that security.
Need more guidance on where to build your DeFi app? Check out our free guide to Web3 ecosystems in 2022.