In 2015 Ethereum, a decentralized open-source blockchain started and quickly became the second-largest blockchain in the world. Ethereum also became the platform where ‘DeFi’ or ‘Decentralised Finance’ projects are built upon. DeFi is a blanket phrase for the cryptocurrency world where there are no intermediaries and everything is governed using smart contracts, which act as its backbone. These smart contracts are binding and once executed cannot be reversed. DeFi is a network of computer encryptions, commonly referred to as protocol of smart contracts, which mirrors the traditional financial services such as lending, exchange, or asset management, DeFi transactions are constructed through smart contracts that can be represented by quantitative values that are transferable, often known as “tokens”.
The conventional financial system is based on trust and in a centralized manner, which is regulated by the central bank and with different intermediaries such as money exchange institutions, banks, or other brokerage firms. This conventional system has often seen failures such as inflation, the economy collapsing and many people still lacking access to these financial institutions. Traditional financial institutions in their most basic form, raise funds in the form of deposits, bills of exchanges, or even shareholder equity, and then lend them out to persons in need of capital in exchange for interest revenue. They take on a variety of risks in doing so, including interest rate risk, maturity mismatch risk, and credit risk. DeFi aims to tackle all of these concerns that are in the traditional financial system because there are no such intermediary organisations in it to take on these risks, making it more efficient.
A 2021 report on global cryptocurrency adoption has ranked India 2nd and by, another report India has been ranked 6th in terms of global DeFi adaptation. These reports are a clear indication of India’s positive reaction towards cryptocurrency and DeFi. The latter mentioned report’s findings also show that larger value transactions accounts for the majority of DeFi activity, demonstrating that DeFi is a common investment strategy among larger investors. Even though DeFi is showing attraction from large investors, it can also be utilized by the common man. For example, when a person buys cryptocurrencies with the intention of holding them for some period, the coins have no utility in the period but with DeFi lending, an individual can put his cryptocurrency as security and obtain loans. The lender, on the other hand, offers his capital in order to receive interest. Compound, one of the earliest and largest DeFi lending platforms has issued billions of dollars’ worth of loans according to its tracker. According to the World Bank’s report, 190 million adults in India still lack access to bank accounts and traditional international money transfer remains costly where merchants must pay a fee of 2- 3% for each card or online transaction and small firms find it difficult to obtain bank credit. DeFi innovation will be able to solve these above issues in India through its smart contracts leading to a math-based trust system, legal enforcement being replaced by cryptographic enforcement, and third-party auditing being replaced by its open-source code and public ledger. Furthermore, the 2020 recessions exposed the flaws in a stagnant and unchanging banking sector, inspiring many people to seek a better path forward.
Regulation of digital assets in India remains one of the hottest topics among investors and stakeholders. While proper legislation is yet to be achieved in India, there has been certain clarity to digital assets in regards to the taxation part which has enabled a little hope for regulation of digital assets. The lack of regulation hurdles still cannot be ignored. Firstly, as more tokens enter the market, their volatility has risen dramatically. Secondly, the Defi smart contracts are still in the early stages of technological progress which runs the danger of having defects that can cause the owner to lose money. Thirdly, DeFi due to being decentralized may be unreliable in terms of accountability. No central entity can be held responsible for decentralised platforms if they are eliminated. Central entities have the advantage of being able to temporarily stop or restore a decentralised platform in the event of a problem; without them, this would be impossible. Furthermore, too much transparency which is a key component of DeFi might compromise privacy. Transactions are viewable on a public blockchain to create trust perhaps will jeopardise privacy. Lastly, people still lack the education necessary to comprehend how to utilise cryptocurrencies and blockchain properly.
Although DeFi has the ability to completely transform the financial ecosystem of our country it is still in the early stages, DeFi based protocols are continuously developing, from the basic blockchain networks to decentralised applications front-end user interfaces. Rural financial inclusion will be required for DeFi to be implemented successfully in India, but it will be constrained by legal uncertainties due to lack of proper legislation or rules and the limitation of current economic infrastructure in India. These are difficult challenges to address, and unless an institution makes an effort to do so, effective execution will be difficult. DeFi’s capabilities could help improve the economic situation of the average Indian, and given that the country’s larger investors are already enthusiastic about DeFi’s potential benefits, government support will be critical to its success. Especially now as the world emerges from covid fuelled recession. If these concerns can be resolved, DeFi could result in a fundamental change in the financial industry, contributing to a more stable, open, and transparent financial infrastructure in India.