Gone are the days when only a privileged few had access to financial services such as trading and investing. In just a decade, the financial space has transformed into a highly inclusive ecosystem where users can manage investments at the click of a button.
This growing accessibility has been complemented by the massive growth of crypto currencies in the last few years. An interplay of these factors has caused a paradigm shift in the world of finance. At the forefront of this shift lies the cutting-edge service called ‘DeFi’.
What is DeFi?
Short for Decentralised Finance, DeFi is a branch of financial services where the flow of money is not controlled by any one central authority. It offers an alternative to traditional financial institutions, where power is centralised around a chosen few.
To achieve the ‘decentralisation’ of power, DeFi runs on an innovative infrastructure using blockchain technology and ‘smart contracts’ (programs that automate the execution of transactions). All processes are handled purely via code. This eliminates the need for middlemen and brings game-changing features to the world of finance.
Asset managers and crypto hedge fund managers can leverage these features of DeFi for a completely new experience of active asset management.
The first radical feature of decentralised finance is that it is ‘permissionless’ and ‘borderless’. ‘Permissionless’ simply means that you don’t need anyone’s approval before using DeFi, and ‘borderless’ implies that you can access it from any part of the world. Thus, DeFi has absolutely no barrier to entry- all you need is a connection to the internet.
This creates an environment where thousands of new investors are encouraged to enter and explore the markets. Asset or fund managers reap the most benefit from such a situation- they get exposure to a huge number of potential clients who they could not have encountered through TradFi (traditional finance).
The second aspect of DeFi is that it is completely transparent in nature. As soon as a transaction is processed on the blockchain, it instantly becomes viewable to the public. For fund managers, this means that their past performance can directly be verified on the blockchain, by anyone and at any time. For investors, this means complete protection from false information and undisclosed activities related to their money.
Not only do these investors get track records of the asset managers, but they also get full control of their own investments. DeFi is ‘non-custodial’ – the investors retain full custody of their assets and can exit funds whenever they wish. Fund managers may only manage the funds- they cannot withdraw the investors’ money for themselves.
Finally, the third unique facet of DeFi is that it is ‘composable’. Technically, ‘composability’ is a programming feature through which the separate components of a system can be put together in many different combinations. This is what allows all parts of the DeFi ecosystem to work in tandem with each other.
Thus, various components of DeFi such as decentralized exchanges (DEXs), lending protocols and futures markets can be easily integrated into one other, creating new forms of financial services never thought possible. Moreover, the open-source nature of crypto and DeFi ensures that these financial services are constantly upgrading and improving upon each other.
But it’s not just innovation that ‘composability’ offers – new DeFi integrations can also be very profitable for active asset managers. Fund managers can combine different elements of the DeFi ecosystem to form highly lucrative strategies and make huge returns for their investors.
It is the possibility of such colossal returns that attracts many people to the DeFi space. However, it is important to mention that decentralised finance is still in a stage of infancy. The experimental nature of this space exposes it to several major risks such as hacking, smart contract vulnerabilities, front running and governance exploits.
But despite the above risks, the exciting nature of DeFi continues to attract both new and experienced players alike. By offering easy entry into the lucrative crypto assets market, DeFi has brought an exponential number of people to the financial space. In just the last two years, the number of DeFi users has jumped from about 91,000 to almost 5 million.
Clearly, DeFi has taken the world of finance by storm – it is the most accessible, transparent and dynamic alternative to traditional finance as of today. And even though the long-term prospects of DeFi remain to be seen, its ground-breaking features clearly point towards the asset management of the future.
The writer is co-founder at DeFiVerse.