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The human being naturally wants freedom and is relatable with the financial sector. The traditional banking system has been running for a long time, but the challenges of executing many financial transactions are increasing daily. Due to population growth, increasing reach of technology, etc., the centralized banking systems which themselves are opaque, and non-interactive, can be induced by corruption, payment defaults, and fraud. So, their reliability is deteriorating day by day. Some notorious issues facing the finance sector are as follows:

Risk of single-point failure
Regulatory pressure
Operating expenses are high
Lack of trust in the centralized banking system
Slow process
Identity theft concerns

DeFi and its background:

There is no solid and universally accepted date when decentralized finance (DeFi) was born, but some analysts believe that decentralized finance was born after the birth of Bitcoin. However, here are some important events that inspired DeFi to come in a more refined form. No matter whether Bitcoin should be considered as DeFi or not, it was a core enabler of DeFi because Bitcoin itself was based on the Distributed Ledger Technology (DLT). Bitcoin allows borderless payment and in the finance sector, it was a revolution that the transactions are transparent and can be seen in the blockchain network. After Bitcoin, the Ethereum blockchain network came into existence with the revolutionary feature of smart contracts. The robust financial ecosystem would need a wide range of services like lending, borrowing, derivatives, insurance, quick payments, etc. but Bitcoin appeared to be simple as it has script limitations so it is not suitable for the wide range of applications to integrate into the blockchain network. It was the key factor in creating the Ethereum blockchain network.

Ethereum quickly became popular after its release in 2015 as it allowed developers to create games, dApps, different token standards like ERC-20, NFTs and so many applications for different industries. These features enabled DeFi to grow up as MakerDAO(The oldest DeFi project) was created on the Ethereum blockchain network with stablecoin Dai. The year 2017 was the most significant to start the trend of DeFi as MakerDAO, decentralized exchange (DEX) EtherDelta, and decentralized ICO were initiated in this year.

In 2019, Compound Finance was launched for borrowing and lending of collateral on the decentralized system where interest rates are set automatically by the algorithm. Compound finance was the key platform to initiate yield farming or liquidity mining in the DeFi sphere. Well, this is just a brief history behind DeFi. Now it’s to discuss more the current trend of DeFi, persisting problems, and solutions, the future of DeFi, etc.

Concept About DeFi:

DeFi ("Decentralized Finance") is the term used in the crypto world for financial services based on blockchain technology, mainly in the Ethereum blockchain network. With DeFi, you can freely access most of the services supported by banks such as interest earning, lending, buying insurance, various business derivatives, borrowing, buying and selling assets, and more.

DeFi is faster than traditional financial technologies and does not require cumbersome paperwork or third parties as it is based on decentralized blockchain technology that is fair and transparent.

DeFi vs Traditional Finance:

There are some remarkable differences between traditional finance and DeFi which are as follows:

What can we do with DeFi?

There are so many attractive features that DeFi offers to you. For those people who cannot use traditional banking services, DeFi can be the best alternative for them because it promises to give full financial freedom.

Features of DeFi:

Features of DeFi can be observed from the following demonstrative graphics:

Financial products on DeFi:

There are so many products and services based on the DeFi some of them are demonstrated in the following figure.

Ethereum blockchain-based DeFi:

No doubt, Ethereum’s smart contract features allow so many dApps to run on Ethereum. Anyone with an internet connection and devices can easily access decentralized financial products and services on the Ethereum blockchain network. There were several reasons that Ethereum was the perfect foundation for DeFi after the creation of the Bitcoin blockchain network.

Ethereum as a public blockchain network, allows users to give financial freedoms so the DeFi platforms built on the Ethereum blockchain don’t hold your money, so you can have full control over all the activities and money.
Ethereum allows the creation of NFTs and ERC-20 standards tokens so DeFi platforms can come up with their governing tokens.
Smart contracts allow transactions to be executed automatically on Ethereum.
Transparency is genuinely maintained so that every transaction record can be traced on the public ledger.
Smart contract-powered financial transactions are directly associated with the blockchain that is immutable so no one can modify the records once an operation is performed.
The transparent rules can be encoded on the Ethereum blockchain networks to establish DAO (or decentralized autonomous organization) to eliminate centralization.

The working mechanism of DeFi on Ethereum:

Indeed, DeFi is still in the experimental phase, it is an emerging digital financial infrastructure that aims to remove centralized intervention to approve the transactions. DeFi is indeed deeply interconnected with blockchain, whose specification is a decentralized, irreversible, public ledger and is based on the Ethereum blockchain – which enables all nodes or computers in the network to keep copies of the transaction's history, and that record is available to everyone.

There are several layers of DeFi:

The blockchain: This is the first layer. Ethereum keeps the records and states of transactions.
The assets: ETH is the main currency of Ethereum apps, so it is used to pay the transaction fee in the mainnet of Ethereum. Developers are also free to create other tokens on Ethereum.
The protocols: The smart contracts of the Ethereum that provide the various functionalities are the protocols.
The applications: Some products or dApps can be used for various purposes.

There is a smart contract that replaces the centralized financial institution in the transaction and such contracts perform the operations as programmed. Different types of contracts can be created to perform the operations automatically, for example, recurring interests can be automatically paid. Here no open can change the contract to steal money, that’s the beauty of DeFi.

Not just the advantages of the Ethereum-based DeFi, there are some notorious downsides which are as follows:

Despite Ethereum being decentralized, community members should still trust the tech-savvy technical members of the Ethereum community to read and rewrite the open-source codes if needed.
There is uncertainty about the Ethereum blockchain itself undergoing get a switch from the PoW to PoS consensus algorithm if any mistakes are made when transitioning from the previous version to ETH 2.0, it could bring difficulties and complexities to the existing or new DeFi projects.
Another most notorious problem of the host Ethereum blockchain is scalability i.e. it can just process about 13 transactions per second, but the centralized payment systems can still process thousands of transactions per second which means this is not looking effective be the alternative of the traditional financial systems.
Network congestion and manipulation of mining fees from the miners is another annoying factor in leaving transactions unprocessed for a long time.
Low Interoperability is another issue of Ethereum integrating so many dApps on the different blockchain networks.
Ethereum is still based on the PoW consensus algorithm which means energy consumption is very high to run the mining equipment.

Other Blockchain-based DeFi:

Undeniably Ethereum is still a trusted home for many DeFi projects as most of the DeFi platforms were initially created in it. Now, most of the emerging blockchains are focused on promoting DeFi applications in their ecosystem and are constantly making efforts to solve the various problems that are emerging in Ethereum-based DeFi.The ETH gas fees are very high, and since the scaling problem is still the same, transactions are not verified for too long, and due to these factors, DeFi platform developers making the shift to fast, safe, and cost-effective blockchain networks such as Solana, Everscale, Cardano, Polygon, Avalanche, Polkadot, etc. The second-largest public blockchain Ethereum is itself getting switched into the PoS(Proof-of-Stake) consensus algorithm from its PoW(Proof-of-Work) consensus algorithm. These high-tech blockchain networks are powering up the different DeFi platforms to run smoothly.

What new techs are introduced in the new blockchain networks?

Ethereum inspired developers to create next-level blockchain technology with improved scalability, low latency, high throughput, etc. They tried to overcome most of the limitations of Ethereum-based DeFi. Here are some impressive techs and solutions developed by the different projects.

The blockchain project Solana has introduced the new consensus algorithm i.e. Proof-of-History to make the network more scalable, low fees for DeFi, and high speed to process the transactions. Now, any sort of DeFi project including Metaverse is being built on Solana like Play-to-Earn economy-based gamings, decentralized exchanges (DEXes), assets management tools and frameworks, margin tradings, decentralized lending, and many more.
Another blockchain Cardano came up with the smart contract feature after its most anticipated Alonzo upgrade on Sept. 12, 202. Cardano’s new smart contracts functionality attracted so many developers to create exciting dApps in its ecosystem. Cardano has done its best to improve the scalability power of the DeFi, and it has crucial applications for the identity management sector.
Polkadot Blockchain helped create a unique DeFi ecosystem as it changed the course of decentralized interoperability across different networks, meaning that various DeFi platforms built on Ethereum and other blockchain networks can be connected to Polkadot through the bridge and is a top-level blockchain network of chains with different chains including Relaychain and Parachains for DeFi. It inspired us to strengthen the effectiveness of the platforms practically. Various DeFi projects are being built on the Polkadot blockchain network both native and Parachain such as Polkadot some of the influential DeFi platforms are SORA, Acala, etc.
Everscale is another unique PoS blockchain network that has an incredible scalability feature. It introduced some unique features like self-healing, multi-sharding, distributed programming, low latency, high throughput, and many more to power up the DeFi. The architecture of the Everscale blockchain is divided into the following components: masterchain, workchains, and shardchains. So, the different blockchain-based DeFi can be bridged with the Everscale blockchain network.
Another blockchain network to mention here is Polygon which has been proving itself the best host Ethereum scaling solution to run various DeFi-based applications. Polygon allows faster transactions at the cheapest fee, so developers could find Polygon is the best option to run dApps at the cheapest fee which are the most desired features in the good DeFi platforms.
DeFi protocol Alchemix has an interesting “Self-Repaying Loans” feature that allows you to leverage a range of tokens without risk of liquidation, which means it allows you to borrow up to 50% of your deposit instantly on this platform.
The decentralized asset exchange protocol Synthetix.io brought unique features i.e. synthetic assets mint, exchange, and liquidity add to the various assets. For the concept, the synthetic asset is simply tokenized derivatives that create the value of other assets in the DeFi ecosystem.

Benefits of new blockchain-based DeFi:

Currently, we have highly powerful and scalable blockchain networks to host DeFi, so we can get so many advantages from such high-tech DeFi platforms. If we locate the development progress of DeFi from DAO to synthetic assets, it has unlocked so many possibilities for users all around the world. Here are some of the crucial benefits of the latest DeFi platforms listed below which are themselves proof that DeFi is more than just experimental tech.

Transactions are processed quickly with the lowest fees which helps different DeFi platforms run smoothly.
New DEXes are created with advanced features like lower fees and faster transaction settlement to allow users to have full control over their assets.
PoS blockchain-based DeFi allows users to stake their tokens to earn passive incomes better than the interest rates paid by traditional banks.
It allows for the creation of different decentralized data analytical tools to predict the market.
Different blockchain-based assets can be bridged to transfer the values easily.
Latest high-tech blockchains allow the creation of advanced in-game economies like Metaverse-based gaming has DeFi to create decentralized infrastructures.
Due to the various exciting features like cheap transaction costs and high throughput to scale both transactions and operations, so many nodes can perform the operations at the same time without lagging.
It has created opportunities for Fintech-based institutions and developers to create new products and services to get tuned with real-life use cases.
Identity management is another crucial use case of the latest blockchain-based DeFi. The DeFi protocol that is integrated with the blockchain-based identity systems can help users to manage their identities for undisputable ownership.
It allows the creation of DeFi platforms with margin trading features and a marketplace for digital collectibles.

Downsides of the latest blockchain-based DeFi:

Due to the pace of technology and the growing demands of users across the world, the latest DeFi platforms also have several downsides. Some of them are listed below:

Smart contract vulnerability has always been the major security concern for so many smart contract-based DeFi projects. A minor bug in the system can cause an expensive loss.
A single-point failure can be possible even in the latest DeFi platforms if hackers detect the wormhole in DeFi platforms.
Host blockchains of the latest DeFi platforms are not fully free from human intervention like validating the transactions, adding the new blocks to the chain, adding the new transactions into the new blocks, etc.
Big data inadequacy is another crucial problem because each block of the blockchain has a limited capacity to store the data. Till now, no advanced blockchain networks have been created to allow DeFi platforms to store or exchange the bigger size files across the connected nodes.
Lack of high-quality IoT devices to store and distribute data in the decentralized ecosystem.
Transaction records are public, so scammers could trace the records to spot the transaction patterns to scam users.
The price of DeFi-based tokens is highly volatile, so their price could fluctuate very quickly.

Future of DeFi:

Developers are doing great to create new innovative solutions to overcome the above limitations. The total value locked in the DeFi protocols indicates the growing demands and popularity of DeFi across the world, so it has to be simple to access, cheap, fast, and driven by advanced technology. Different tools and derivatives are contributing DeFi to achieve exponential growth, but that is not enough. The success rate of a good DeFi is determined by how the market is permissionless and accessible to anyone. The composability feature is the most anticipated to mix different blockchain-based DeFi solutions in a single place to create other products and services.

DeFi is rapidly evolving and refining – there are many possibilities for it to emerge as a viable alternative to the traditional financial services ecosystem as it is cheaper, faster, safer, transparent, and more relevant. This new form of decentralized financial technology may influence centralized financial institutions in the future and inspire them to transform themselves. Not only that, the world is now taking a separate leap in technology.

Scientists are making progress in the development of high-level quantum computers. New technology will be used in the manufacturing of powerful IC chips and IoT sensors so that shortly, small and high-end devices will be available in the market, which will help to take DeFi to the next level. So, the other most important tech is Artificial intelligence (AI) (for machine learning and so many other purposes). The fusions of Quantum computers and AI would inspire the world to have growing adoption trends of DeFi.

Let’s understand how AI and Quantum Computer could change the DeFi world systematically as follows:

Quantum Computers:

The Quantum computer is the next generation tech that works not with bits but with quantum bits (qubits) with optimized performance. Its working principle is based on the superposition i.e. Unlike the dualistic processing systems based on High (1) and LOWs(0s), it can simultaneously be 1 and 0, or a mixture of both HIGH (1) and LOW (0). Quantum computers are based on the laws of quantum mechanics to solve problems that are too complex for classical computers. Here are some key takeaways on how quantum computers assist DeFi to get boosted.

It solves most of the limitations in cryptography. The advanced quantum encryptions could not be broken by any powerful classical computers or the quantum computers themselves. This feature of quantum computers allows developers to create the most powerful blockchain network with enhanced security features. So, powerful blockchain-based DeFi will come up with optimized scalability and high security soon.
Indeed, quantum computers are in their very early stage of development, and both government and private sectors are investing their time and money to have new technological achievements. This innovation of quantum computing could leave traditional cryptographic algorithms based on encryption at very high risk. The new concept of quantum-resistant algorithms is introduced by some experts, but it will not be a sufficient countermeasure to live with the new groundbreaking tech. The encryption of the biggest public blockchain network Bitcoin and other blockchains could also be broken due to quantum computing and its incredible computing power. So, it will be better to invent a new course of programming targeted at quantum computing and DeFi will evolve according to the same pace of technology.
Shortly, a very powerful smartphone could change how we interact with the DeFi world. Even the very complicated tasks that we believe so far will be easier to solve by using quantum computing-enabled smartphones.
Improved storage capabilities and processing powers of future computers allow blockchain to share bigger-sized data across the cluster of computers without lagging. It will be the real use cases for the Metaverse-based DeFi, video gaming, and other DeFi projects that are designed to perform complicated tasks.

Artificial intelligence (AI)-based DeFi:

Imagine, what would happen if every functionality of DeFi were based on advanced AI? Some companies have already implemented AI and machine learning features to compile a huge load of tasks that were complicated and time-consuming for manual processing from human workers. This is a good sign that future AI is going to bring a new era to the decentralized ecosystem by removing human intervention for various tasks. Good AI-based operations will be unbiased and fair, so users can trust the platforms for seamless operations. Here is a list of what we can expect from advanced AI in the future:

Chatbots that are designed for customer care services will get better performances. They will be able to analyze and deliver the desired information to users and Offer 24/7 support.
Online security will be improved so that users can perform transactions without any fear of scammers.
No human error while performing so many activities in a very short duration.
Trading and marketplace will be more convenient to use.
DeFi platforms will have easy-to-use UI so any sort of users (Including physically disadvantaged people) can easily use the platforms.
Users will have more control over their data and privacy.
AI-enabled systems detect fraudulent transactions quicker than human analysts.
It helps to analyze a huge overload of data and instruction.
Assist to identify the process improvements.
So many advanced analytical tools can be built not just by the private sector, government can also use such tools for various purposes.
AI verifies the real and fake users to grant ownership of the different assets.
It assists in solving very complicated problems based in the finance sector.
Another crucial use case is automation which means it assists in resolving disputes between two parties and allows smart contracts to execute transactions automatically.

These are just a few points for real-life use cases of AI-based DeFi. You can find more information in this article too.

Closing thoughts:

So, the future of DeFi is bright as it will remain an interesting tech to go for mainstream adoption trends. With the use of many advanced technologies, future DeFi will appear in a more advanced and refined form in the future. As the quantum computer and AI will be integrated into the DeFi platforms, it will reduce human interference in performing various tasks. Using technologies like artificial intelligence and machine learning will automate various tasks like service flow, analytics, etc. and robotic process-based DeFi will help businesses make better decisions. The more captivating aspects of DeFi, the more challenges it has to face in the future, such as money laundering, theft, smuggling, tax evasion, government regulation pressure, etc. Defying all the challenges, DeFi would follow the golden journey of the future. Let's hope this new and innovative technology that gives everyone financial freedom will take a pioneering leap.