*https://medium.com/racecapital/defi-infrastructure-101-overview-market-landscape-78e096a85834*
Chris McCann, June 2021
Decentralized Finance (DeFi) is redefining the future of finance. There is a major shift going on in the underlying infrastructure powering financial applications, and it’s changing the way we think about permission and control, transparency and risks.
DeFi is a developing market sector within the intersection of blockchain technologies, digital assets, and financial services. According to DeFi Pulse, the value of digital assets locked into DeFi applications grew 10X from less than $1 billion in 2019, to over $10 billion in 2020, and over $80 billion at its peak thus far in 2021. Yet the DeFi applications and underlying infrastructure are still in its nascent stage of development.
The goal of this report is to provide an introduction of the new emerging area of DeFi infrastructure powering DeFi apps today. While it’s easy to get caught up in the hype and speculation within the space, I’ll focus on the key components of DeFi applications, their key differentiation compared to traditional finance, potential risks, and longer term implications these DeFi apps are causing.
DeFi apps are financial applications with no central counterparties. In practice this means there is no institution (e.g. banks) you are interfacing with to access these financial applications; instead users interface directly with the programs (e.g. smart contracts) on top of the protocol itself. For more of a DeFi 101 primer I highly recommend this report.
The major categories of DeFi apps include decentralized exchanges, lending platforms, stablecoins, synthetic assets, insurance, among others. While diverse in scope, all of these DeFi apps share a major set of commonalities including:
Compared to traditional financial applications which use core banking systems (Fiserv, Jack Henry, FIS, etc.) as the underlying ledgers of record, DeFi apps use blockchains as their underlying core ledger.
A few of the most prominent blockchains used to build DeFi apps include Ethereum, Solana, and Binance Chain, etc. These underlying blockchains store the ledger state of what is deposited into the DeFi apps, what is stored within the smart contracts, all of the transactions, and withdrawals.
All of the core accounting functions to ensure matching inputs and outputs are handled by the blockchain itself, the DeFi apps don’t need to create external systems to reconcile balances, because all of the transactions are queryable across the various block explorers.