Decentralized Finance (DeFi) has introduced a new paradigm in the financial markets, one that leverages blockchain technology to replace central intermediaries. Unlike the approach taken by traditional financial institutions, DeFi is designed to enable anyone with a computer and stable internet connection to access various financial services with ease.
In the current market setup, it is an uphill task for retail investors to access most of the financial instruments. This is because of the existing hurdles, some of which are intentionally placed to lock out a certain class of investors. For instance, one requires a to have achieved a certain wealth threshold or qualifications to participate on global stock markets such as the NYSE, let alone purchasing commodities like gold.
With DeFi, that is not the case. This burgeoning cryptocurrency niche is perhaps the most accessible financial service ecosystem in modern-day markets. It currently features services such as lending and borrowing, derivatives and decentralized exchanges (DEXs). The latter category has become particularly popular, with platforms such as Uniswap and Polkadex offering crypto users decentralized avenues to trade.
Moving Away from Centralized Market Structures
Despite existing for over a century, centralized market structures are yet to achieve the desired outcome. These marketplaces have become exclusive for a few ‘elite’ members, locking out the larger majority who really need the financial services. That being the case, it is no surprise that today’s investors, especially millennials and generation Z are pivoting to decentralized markets, favouring the growth of the crypto ecosystem in recent years.
Before taking a deep dive into the value proposition of DeFi, let’s first breakdown some of the shortcomings in centralized finance to understand why the shift is necessary.
As mentioned earlier, traditional finance excludes the small fish or rather it is structured to favour big players such as banks, brokerages and investment firms. These financial service providers have dominated global markets for decades, posing as the saviours while in real sense they are majorly concerned with raising their profits.
The centralized financial institutions often create obstacles to limit the normal retail investor from purchasing the most lucrative assets. Instead, they position themselves as the go-to players to access the market. This comes at a significant cost, leaving the opportunities to investors with deep pockets.
2. Market Inefficiencies
Centralized market structures have in the past fallen victim to arbitrage, given that an asset’s price on one exchange could be different on another. This is evident in centralized crypto exchanges; for example, the ‘kimchi premium’ causes Korean crypto exchanges to price digital assets higher than the prevailing fiat exchange rates. This causes a market inefficiency, leading to arbitrage scenarios which might benefit a few but negatively impact the whole market.
In addition to mis-pricings on different exchanges, centralized market ecosystems are less liquid than on-chain platforms. A trader on Binance or Coinbase could be looking to fill a large order but fail due to limited liquidity within the exchange; however, with on-chain trading platforms, liquidity can be sourced across various protocols and orders filled accordingly.
3. Single Points of Failure
Traditionally, financial markets rely on centralized databases to store information and facilitate trades. Well, there is a serious danger in this approach; systems are prone to shortcomings such as overloading, hacks or information tampering. Should a centralized exchange be exposed to any of these challenges, it means that traders will ultimately be affected (Single point of failure).
Notably, technicalities are not the only limitations that could result in a single point of failure, other factors such as regulations and local laws can cause the shutting down of a centralized financial service provider.
DeFi; The Future of Financial Markets
Thanks to the introduction of DeFi, there is hope of changing the nature of financial markets from centralized to decentralized ecosystems. DeFi solves each of the above shortcomings to a significant extent. At the very basic, decentralized exchanges (DEXs) such as Polkadex allow anyone to trade featured assets and eliminate the possibility of a single point of failure.
Built on the substrate infrastructure, the Polkadex platform is among the leading DeFi-oriented DEXs designed for the new era of financial markets. This DEX features a peer-to-peer orderbook-based crypto trading platform, allowing users to exchange digital assets in a trustless environment (without going through an intermediary).
For institutional users looking to access DeFi while remaining compliant, Polkadex offers an optional and decentralized KYC tool. In doing so, the project is optimistic of attracting more liquidity to decentralized markets. Other notable functionalities of this futuristic DEX include an IDO pallet, high frequency trading and support for new token generation.
As much as DeFi projects like Polkadex are showing potential, it is not a bed of roses; decentralized markets are still in the early stages of development. Many things are yet to be fine tuned, one of the major challenges is the constant threat posed by anonymity; a loophole that scammers are exploiting to siphon funds out of unsuspecting investors. Investors ought to carry out proper due diligence before interacting with decentralized protocols/markets.
Based on the ongoing developments in FinTech, we could speculate that crypto was the much-awaited catalyst to unlock the next era of finance. Decentralized ecosystems will usher in trustless and distributed market structures, enabling people who were previously locked out to enjoy a piece of the pie. The next few years will be quite deterministic; signs are showing the middlemen might soon be packing their bags.