This can be seen as an extension of Balaji Srinivasan’s piece Yes, You May Need a Blockchain.

As of 2021, the global fixed-income market was worth $126.9 trillion, the global equities market was worth $124.4 trillion, and the global derivatives market was estimated to be over $600 trillion. The exact numbers may be different now, but the point is that it is the capital markets that are responsible for driving funds to the best ideas and enterprises.

You might wonder, what’s the need for Decentralised Finance (DeFi) when Traditional Finance (TradFi) has already brought humanity so far and facilitates trillions worth of economic activity every day? For example, the capital markets provide 75.4% financing for non-financial corporations in the U.S. Well, that’s the exact reason; it has become too important and forms the bedrock of a country’s economy and the global economy.

One area where TradFi has fallen short and may never reach the desired level is financial inclusion. Despite TradFi existing for multiple centuries, 1.4 billion adults remain unbanked globally. Further, people born in developed countries like the U.S. have a disproportionately better chance to prosper than those born in Mozambique or Afghanistan. TradFi does little to enable people from poor or war-torn countries to share in the prosperity of nations with developed financial markets. In addition, TradFi is fully functional only during specific times on the weekdays and is shut down the rest of the time. Finance shouldn’t be this inefficient and technologically archaic in the age of the internet and blockchain.

But, there is no real incentive for TradFi institutions to innovate or reform. The most prominent financial institutions generate over $100+ billion in profits in a year with no real downside, as central banks are forced to provide backstops whenever things go south. No one knows the extent of systemic risk built into TradFi institutions, as most of them are bloated with bailout packages and cheap capital – starting with the Savings and Loan Bailout of 1989, followed by the Bank Rescue of 2008 and the Covid 19 Pandemic liquidity packages.

https://twitter.com/jantonypaul/status/1578680652098338822?s=20&t=bespJ1TGD5GvzHk2nyuzzw

We have already started to see fault lines emerge in the form of failed economies, hyperinflation and people going to extremes to get their money out of banks.

So, what can be done if TradFi can’t be reformed? We can exit fast-failing TradFi and opt into DeFi, which, simply put, is better technology.

https://twitter.com/balajis/status/1495526837333594113

If done right, DeFi has the potential to create robust and more efficient financial institutions which are accessible to everyone worldwide without being forced to be subjugated to local turmoil. This could be akin to the GST reform in India, creating a unified market and enhancing efficiencies throughout the economy. Here are some of the capabilities DeFi enables:

DeFi is powered by blockchain and smart contracts, which means no personnel is required to make it work. Once a smart contract is created, it is indestructible and will continue to function forever. So, whether it’s a weekend or a national holiday anywhere in the world, DeFi functions as usual.

It can seem complicated and intimidating for someone unfamiliar with blockchain and DeFi-specific jargon. But with little effort, for the first time in the history of money, you will be able to have full ownership over your funds, whether it’s $100 or billions of dollars. Over time the complexities will get further abstracted away, and DeFi will become easier to use, like the internet.

https://twitter.com/davidmarcus/status/1578795041719750663

Regardless of geography, anyone with a crypto wallet and an internet connection can access DeFi without needing intermediaries. Permissionless finance becomes critical as more regimes increasingly use TradFi institutions to de-platform people for political and commercial reasons. This is a game changer, especially for citizens of war-torn countries, countries with underdeveloped financial markets or oppressive regimes. DeFi enables people to exit old regimes and enter new regimes with their savings intact. All they need to do is remember a 12-word seed phrase.

Apple’s stock began trading publicly on Dec. 12, 1980, at $22 per share. If you had invested $1,000 into the company during its early days, it would be worth roughly $1.6 million today. But to benefit from Apple’s success or USA’s remarkable prosperity over the last multiple decades, you needed to be either its citizen or an affluent individual or institution.

Now DeFi opens up these opportunities for everyone. For example, you can seamlessly gain exposure to Tesla, Apple, Google, Facebook, Amazon, Netflix or TSMC from anywhere in the world using exchanges like Mirror.

Smart contracts are published on a blockchain, and records of completed transactions and codes are available for anyone to review without fully revealing their identity. This facet of DeFi dramatically reduces the possibility of fraud, mismanagement or exploits.

With DeFi, it will be nearly impossible for incompetence and mismanagement at institutions like Archegos Capital, the American International Group or the whole American Financial System during the 2008 sub-prime mortgage crisis to go on for that long.

It’s common practice to borrow against - a certificate of deposit, insurance or shares in TradFi, but the process can be cumbersome and time-consuming. DeFi takes composability, which means combining different components within a system to support new use cases in a permissionless manner to a whole other level. Composability enables users to carry complex strategies like borrowing ERC-20 tokens from one platform, converting them into another ERC-20 token on another platform, using the converted token to swap it with another ERC-20 token, and so forth.

For example, users can stake their Ethereum on Lido to earn 5.2% APR. Lido, in turn, issues an equivalent stETH token representing your claim to your staked Ethereum. While your staked Ethereum is making 5.2% APR, you can use the stETH as collateral across other DeFi protocols to earn additional yield. All this can be done without interacting with an intermediary, enhancing capital efficiency and ease.

Local payments are still clumsy in significant parts of the world, let alone international payments. Even in countries with developed financial ecosystems like the U.S., making cross-border payments takes 2-3 days and requires a myriad of paperwork and a fee of around $40. Meanwhile, crypto is borderless by design, settlement is instant, fees are often less than $1, and since everything is on-chain, the risk of fraud is significantly reduced.

Crypto payments are increasingly becoming popular. Many financial institutions, such as remittance players and card networks, are forced to adopt it, as it has faster settlement cycles and offers access to new customer segments. That’s why we have recently witnessed so many integrations between TradFi behemoths and crypto protocols.

Slowly, then suddenly.

https://twitter.com/0xPolygon/status/1517553896054730752?s=20&t=d9VpwCeWqITSVZ1lVXUD1A

The most crucial facet of DeFi is decentralisation, i.e., no single entity can alter how a protocol or network functions. Decentralisation enables users to go from mere users to owning the protocols they interact with eventually.

Take the example of Uniswap, one of the core DeFi protocols. 60% of UNI, the governance token of Uniswap, is allocated to the community. Historical users and liquidity providers have already claimed 15% of the UNI supply. The Uniswap treasury will distribute the remaining community allocation on an ongoing basis through contributor grants, community initiatives, liquidity mining, and other programs, all of which contribute to the growth of Uniswap.

UNI holders can create and vote on proposals, and if the proposal is passed, Uniswap will execute the same. For example, Mihailo, the Co-Founder of Polygon, proposed that Uniswap should also deploy on Polygon. After thorough discussions within the Uniswap community, the proposal was put to the vote and was passed almost unanimously. Now, as of today, Uniswap has a TVL of over $81 million on Polygon.

The Uniswap community is now also experimenting with activating fees on different pools. It’s extraordinary how after thorough deliberation, the Uniswap community started charging fees on the USDC/ETH & USDC/USDT pools on an experimental basis.

DeFi is not a solution looking for a problem, which is reflected by the more than $60 trillion deployed in DeFi. Will TradFi vanish someday, and only DeFi will prevail? I don’t think so. Eventually, a combination of TradFi and DeFi is more likely, as there are certain advantages to both making them more suitable for different purposes. Will finance be much more accessible, efficient and transparent because of DeFi? Absolutely.