In the Web3 world of cryptocurrency, where there is "money," financial services naturally follow. In the real world, there are banks, lending, payments, and insurance; in the decentralized world of Web3, these functions are fulfilled by DeFi—Decentralized Finance.
DeFi is short for Decentralized Finance, which means "decentralized finance." It is a new type of financial system based on blockchain technology that does not rely on traditional financial institutions, providing financial services such as lending, trading, and payments. To truly understand DeFi, we need to compare it with traditional finance.
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Core Differences Between DeFi and Traditional Finance
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Openness
Traditional financial systems require a bank account, and processes like account opening, transfers, and loans go through complex reviews, with some regions unable to access basic financial services.
In the DeFi world, you only need a crypto wallet to participate at any time, unrestricted by geography, identity, or bank policies, truly achieving "financial inclusivity."
- Trust Mechanism
Traditional finance relies on intermediaries like banks and payment institutions, and all transactions must be completed through these centralized entities.
DeFi, on the other hand, relies on smart contracts on the blockchain for automatic execution, with transactions between users secured by code, transparent, and without the need to trust third parties.
- Asset Control
In traditional finance, funds are held in banks, and users do not fully control their funds; banks have the right to freeze or restrict access.
In DeFi, users directly control their assets through a crypto wallet, and unless you authorize it, no one can misappropriate your funds.
- Transaction Time and Efficiency
Traditional finance is limited by business days and settlement times, and cross-border transfers can take days to complete.
DeFi operates globally 24/7, with instant transaction confirmations, allowing funds to flow anytime and anywhere.
- Core Components of DeFi
DeFi is not a single application but an ecosystem composed of multiple decentralized financial services, mainly divided into several categories:
- Decentralized Exchanges (DEX):
Function: Enable free trading of cryptocurrencies, with users in control of their funds.
Example: For instance, if Xiao Ming wants to exchange ETH for USDT, he does not need bank approval and can complete the exchange on Uniswap in seconds, without involving a third party.
- Decentralized Lending:
Function: Borrowing without bank approval, based on digital assets.
Example: For instance, if Xiao Hong collateralizes 10 ETH on the Aave platform, she can immediately borrow 5000 USDT for investment without filling out any application forms.
- Stablecoins:
Function: Pegged to fiat currencies, solving the price volatility issue of cryptocurrencies.
Example: For instance, if A Jie wants to make a cross-border payment to a friend abroad, he can use USDT for quick transfer, saving on high remittance fees.
- Derivatives and Synthetic Assets:
Function: Allow users to participate in leveraged trading, options, and futures through smart contracts.
Example: For instance, if Xiao Li predicts that BTC will rise, he can go long on BTC with 3x leverage on dYdX.
- Decentralized Insurance:
Function: Provide insurance services without intermediaries through smart contracts, protecting assets from various risks.
Example: For instance, if Xiao Zhang purchases smart contract insurance from Nexus, it protects the funds he holds on DeFi platforms. If the platform suffers a hack or a smart contract vulnerability leads to fund loss, he can receive compensation.
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Current Status and Development of DeFi
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Rapid Market Growth
According to Defillama data, as of December 2024, the total locked value (TVL) of the DeFi market has surpassed $100 billion, continuing to grow rapidly.
According to the a16z annual crypto report, as of October 2024, the spot trading volume of decentralized exchanges (DEX) accounted for 14.12% of the total cryptocurrency trading volume. Major centralized exchanges are also pushing into decentralized finance.
According to the a16z annual crypto report, DeFi is a major area attracting developers, being the only category that exceeds blockchain infrastructure, while DeFi accounts for 34% of daily active addresses in the entire Web3 space. It is the most used part of Web3.
Currently, the monthly active users of Web3 are estimated to be between 30 to 60 million. According to data from crypto.com, there are approximately 617 million cryptocurrency holders worldwide. These users are merely passive holders of cryptocurrency and do not count as Web3 users, indicating that there is still significant growth potential for Web3.
- Leading Protocols Dominate the Market
Ethereum remains the largest infrastructure for DeFi, with leading protocols like Lido, Aave, Eigenlayer, and Uniswap occupying a significant market share.
- Rise of Cross-Chain DeFi Ecosystems
DeFi has expanded beyond Ethereum to multiple chains such as Solana, Arbitrum, and Base, enhancing efficiency and user choice.
- Policy and Compliance Trends
Due to its decentralized nature, DeFi can operate globally, rendering traditional management methods ineffective. Its anonymity also makes it susceptible to misuse by criminals for money laundering and fraud. A key issue is that many DeFi platforms are operated by decentralized autonomous organizations (DAOs) or anonymous developers, leading to a lack of clear accountability, making it difficult to hold anyone responsible when issues arise.
In response to these problems, regulatory scrutiny of DeFi is becoming increasingly stringent. U.S. regulatory agencies have issued two official documents targeting the DeFi sector, aiming to bring DeFi under existing legal frameworks, including emphasizing that DeFi projects must fulfill anti-money laundering (AML) and know your customer (KYC) obligations like traditional financial institutions, and clarifying accountability, rejecting claims of "complete decentralization" as a defense, stressing that anyone with actual control over the design, development, maintenance, or promotion of DeFi protocols may be considered accountable.
The overall trend is that regulation in the DeFi sector is moving towards clarity, empowerment, and accountability, with the consensus that DeFi projects must assume traditional financial obligations.
- Conclusion
DeFi is an indispensable financial engine in the Web3 world, reconstructing the functions of traditional finance through decentralization, trustlessness, and global openness. From trading and lending to insurance, DeFi offers a new financial system that is intermediary-free, accessible anytime and anywhere, and controlled by users.
In the future, with technological advancements and improved regulation, DeFi is expected to occupy a more significant position in the global financial system, allowing everyone from farmers in remote villages to workers abroad to enjoy fast, low-cost financial services through DeFi, truly achieving "financial freedom."
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