Central Bank Digital Currency (CBDC) has been a topic of discussion for the crypto community, governments, financial researchers and central banks most recently. The world is going through major adjustments in every sector of the economy as a result of the Covid-19 pandemic, people are now embracing new innovative technologies and ways of doing things that limits physical contact with other humans.
On the other hand, Decentralize Finance (DeFi) is another interesting topic for those in the cryptocurrency community and it has also gotten keen interest from its close competitor the traditional or centralized finance sector. For a better understanding of our topic, let’s take a look at what Central Bank Digital Currency (CBDC) and Decentralize Finance (DeFi) really are.
What is a Central Bank Digital currency (CBDC)?
Central Bank Digital Currency refers to the digital form of paper money or FIAT currency issued by the central bank of a country.
The Journey so far for Central Bank Digital Currency
Central Bank Digital Currency has gathered keen interest from some developed and developing countries central banks. China has been on the forefront of issuing a CBDC with rumors originating of some trials already done. On the other hand Thailand are also pursuing the idea vigorously, recently the Bank of Thailand announced plans to build a payment system using Central Bank Digital Currency.
In Europe, the Swedish central bank is close to issuing an e-krona and has already started testing technical solutions for it in 2020. In Italy, the Italian Banking Association (ABI) has given the green light for the creation of a European CBDC, with the German Banking Association backing this idea, while France’s central bank has given the go ahead to experiment a European CBDC.
The story is the same in Africa, with the Bank of Ghana reiterating its interest in creating a central bank digital currency.
What is Decentralized Finance (DeFi)?
Seeing the name Decentralized Finance (DeFi) for the first time you would feel it refers to an institution or organization.
Decentralize Finance (DeFi) refers to a collection of financial tools, products and services accessed through decentralized applications (DApps) that are not controlled by a central authority like banks, insurance firms, creditors or governments which are completely open source and managed through smart contracts.
How do you access DeFi?
DeFi covers every sector of the traditional financial ecosystem, even the unbanked can have access to financial products and services via DeFi. DeFi can be accessed primarily through decentralized applications (DApps).
Decentralized Applications: DApps are applications that act as an interface to use smart contracts in interacting with the blockchain. DApps are the most important component of the DeFi ecosystem.
DApps are divided into three categories, these includes:
- Money and funds management DApps
- Business process management DApps
- Decentralized Autonomous Organization (DAO) DApps
The DeFi ecosystem is built using these three categories of decentralized applications.
What are the products and services available in DeFi?
Here we will briefly look at vital products and services offered within the DeFi ecosystem.
DeFi Lending and borrowing: This is the booming sector of the DeFi ecosystem. Lending and borrowing are the major revenue generation mechanisms for banks, but in the centralized finance structure it is plagued with loads of paperwork and high interest rates while it is primarily available to only the banked population.
But with DeFi you don’t need to complete loads of paperwork, pay high interest rates or own a bank account in order to access lending and borrowing services. With just enough collateral anyone can access a loan in DeFi, a good example of DeFi lending & borrowing protocol is Compound Finance.
DeFi Payments: Ether and DAI decentralized stablecoin can primarily be used to settle payments in a decentralized manner. But with the growth of DeFi more innovative decentralized payments solutions are developed and experimented. One of such creative DeFi payments protocol is Sablier, which makes you stream payments just like streaming music on Spotify.
DeFi Fund Management: Fund management simply has to do with assets management by a fund manager in order to generate returns on investments. But with DeFi you do not need an investment manager to manage your assets, you simply need to choose from a wide range of automated asset management strategies available. The DApp will have algorithms to conduct trades for you automatically and manage your assets. TokenSets is an example of a DeFi fund management project.
Decentralized Exchanges: This is the most popular DeFi service provider out there. Decentralized Exchanges (DEXs) provide cryptocurrency traders a way to trade cryptocurrencies directly wallet to wallet without an intermediary or storing your funds in a wallet you do not hold the private keys to. Most recently we have seen more creative DEXs being introduced thanks to DeFi, DEXs that makes you trade or swap your cryptocurrencies instantly in real time, these includes Uniswap, Kyber and Bancor.
Decentralized Stablecoins: Due to the high volatility associated with cryptocurrencies, stablecoins were created. A stablecoin refers to a cryptocurrency that holds a stable value backed by a pegged external asset like FIAT, precious metals & stones, basket of cryptocurrencies, collectible cars, etc.
Decentralized stablecoins aim to solve the problem of unverified collateralization associated with centralized stablecoins like USD Tether (USDT). DAI stablecoin by MakerDAO is a good example here. Instead of being backed by US Dollars lodged in bank accounts you can’t verify, DAI is backed by Ethereum held in a cold storage wallet that can be verified on the blockchain.
Decentralized Insurance: Despite the decentralization of DeFi there are still a number of risks involved, like the tokens locked in the smart contract being vulnerable to hacks or bugs being exploited during large payouts.
On the 15th and 18th of February 2020, a DeFi DApp called bZx was exploited leading to a total loss of 3,649 ETH in those two days. This loss highlights the potential risks associated with DeFi, which can be addressed by purchasing decentralized finance insurance cover if you are dealing with large amounts in DeFi. On the forefront of providing DeFi insurance services are Nexus Mutual and Opyn.
Decentralize Finance (DeFi) the journey so far
From our brief introduction of what DeFi really is, you can see DeFi also offers a suite of financial tools, products and services primarily offered in the centralized financial sector. Though DeFi is still experimental, it has witnessed an exponential growth in 2020 and recently the total market capitalization of DeFi protocols combined crossed the $2 Billion mark.
DeFi’s journey hasn’t been smooth with a number of hacks and exploitations of DeFi protocols recorded but overall we believe the future is bright for the Decentralized Finance (DeFi) Industry judging by the successes of Compound Finance, Uniswap, MakerDAO, dy/dx, etc.
Covid-19 pandemic has provided a rare opportunity for the adoption of alternative innovative technological solutions, including the utilization of blockchain technology. Cryptocurrencies have been used for payments and receiving donations by established organizations, including UNICEF. Also blockchain technology has been used to track & verify covid-19 testing kits in China.
In this article the topic of interests are central bank digital currency (CBDC) and Decentralized Finance (DeFi) shining the light on how either or both of them can be key for cryptocurrency adoption. We strongly believe that with the keen interest Central Bank Digital Currency is getting from central banks, it remains a key factor that’ll make digital currencies and blockchain technology go mainstream.
DeFi on the other will provide an opportunity for the unbanked population to access financial services and also provide strong competition to centralized financial institutions that have captured the banked population. People are already utilizing decentralized ways of lending & borrowing, making payments, savings and managing their assets, with the numbers expected to grow.
We strongly believe central bank digital currency (CBDC) and decentralized finance (DeFi) can be key for cryptocurrency adoption due to:
- Central Banks pursuing the idea of issuing central bank digital currency.
- Covid-19 pandemic making organizations and individuals utilize alternative methods of payments.
- DeFi providing financial products and services to the unbanked population bringing about financial inclusion.
- DeFi offering innovative financial products and services providing strong competition to traditional finance institutions.