What is DeFi: Key concepts through DeFi history

Decentralized Finance (DeFi) refers to a system of financial services and applications built on blockchain technology. It is designed to operate without the need for traditional intermediaries like banks, brokers, or centralized institutions. Instead, DeFi relies on smart contracts, which are self-executing agreements written in code and deployed on decentralized networks such as Ethereum.

As of January 23, 2025, the Total Value Locked (TVL) in DeFi protocols reached approximately $123.3 billion.

Ref: DeFiLlama

To better understand this transformative and rapidly evolving sector, let’s explore its history and the key concepts that have driven its growth.

Decentralized digital money (2008)

No exploration of DeFi's history is complete without the creation of Bitcoin, the first peer-to-peer electronic cash system and the foundation of decentralization. Bitcoin introduced the concept of trustless, borderless, and decentralized digital money, paving the way for the innovations that followed.

Smart contracts (2015)

Smart contracts, introduced with Ethereum in 2015, revolutionized blockchain technology. These programmable contracts self-execute when predefined conditions are met, eliminating the need for intermediaries. They became the backbone of DeFi, enabling trustless interactions across decentralized applications.

Smart contracts also introduced the concept of composability, earning DeFi protocols the nickname "money legos." This composability allows DeFi protocols and applications to integrate and complement one another seamlessly, building an interconnected financial ecosystem.

Decentralized stablecoins

Stablecoins, a type of cryptocurrency designed to maintain a stable value, are essential to DeFi. Unlike other cryptocurrencies, which are prone to significant price volatility, stablecoins provide a reliable medium of exchange. They achieve this stability through various mechanisms, such as being pegged to fiat currencies, or commodities, or using algorithms to maintain value.

The first wave of stablecoins emerged in 2014, with USDT (Tether) leading the centralized stablecoin category and BitUSD pioneering the decentralized stablecoin sector. However, the real turning point for stablecoins and DeFi came in December 2017, with the launch of MakerDAO.

MakerDAO introduced Dai, a decentralized stablecoin pegged 1:1 to the US dollar. Unlike centralized stablecoins, Dai is backed by digital assets like ETH. This allowed anyone to:

• Borrow Dai by using their digital assets as collateral.
• Access a dollar-pegged asset without relying on traditional banks.

Dai enabled lending, borrowing, and other financial activities in a completely decentralized way. MakerDAO’s system became the first building block of a permissionless financial ecosystem, inspiring a wave of protocols that now power modern DeFi.

With Dai and other stablecoins, DeFi gained the stability and liquidity needed to grow into a multi-billion-dollar industry.

Automated Market Makers (2018)

In 2018, Uniswap introduced Automated Market Makers (AMMs), a revolutionary alternative to traditional order-book trading. AMMs use liquidity pools and algorithms to determine token prices, allowing users to trade directly from their wallets without relying on intermediaries.

This innovation democratized trading, as anyone could:

• Provide liquidity and earn fees.
• Trade tokens are permissionless.

Uniswap’s simplicity and composability became a cornerstone of DeFi, sparking the growth of decentralized exchanges and further innovations in token swaps.

Yield farming and staking (2019-2020)

The introduction of yield farming in 2019 transformed DeFi into an ecosystem of rapid growth and innovation. Yield farming allowed users to earn rewards by providing liquidity or staking tokens, incentivizing participation in DeFi protocols. This concept gained widespread popularity with the launch of Compound Finance, which introduced governance tokens (COMP) as user rewards.

Compound's success ignited DeFi Summer, a period of explosive growth across the decentralized finance landscape:

• Liquidity Mining: Users earned governance tokens to provide liquidity, which increased user activity and capital influx.
• Staking: Platforms allow users to lock tokens, securing networks while earning rewards and further driving adoption.
• Massive TVL growth: Total Value Locked (TVL) in DeFi surged from less than $1 billion in early 2020 to over $10 billion by the end of 2020.

This era saw the rise of key DeFi protocols like Aave, Curve, and SushiSwap, as well as the mainstream adoption of decentralized lending, borrowing, and trading. The success of yield farming and staking cemented governance tokens as a critical component of DeFi, aligning user incentives with protocol growth and fostering vibrant, decentralized communities.

Multi-chain, layer 2, and cross-chain solutions

As DeFi expanded, Ethereum’s congestion and high transaction fees highlighted the need for solutions that could scale and connect blockchain ecosystems. Multi-chain and cross-chain solutions emerged as innovations to address these limitations.

Platforms like Polkadot and Cosmos introduced frameworks that allowed blockchains to operate independently while seamlessly interacting with one another. These ecosystems enable developers to build specialized blockchains that are interoperable from the start, fostering collaboration across chains.

Cross-chain bridges, such as ThorChain and Wormhole, provided users with the ability to transfer assets between blockchains like Ethereum, Binance Smart Chain, and Solana. These bridges removed the barriers of siloed liquidity, expanding the usability of DeFi across networks.

Layer 2 solutions like Polygon, Arbitrum, and Optimism emerged to enhance Ethereum’s scalability by moving transactions off the main chain, reducing costs and increasing speed.

Restaking

Restaking allows staked assets to be used across multiple decentralized protocols. For example, Ethereum validators can re-stake their staked ETH to secure other protocols while earning additional rewards. This creates multiple revenue streams for validators and increases the utility of staked assets, enhancing the composability and efficiency of DeFi systems.

A prime example is EigenLayer, which enables users to reuse their staked ETH from Ethereum’s Proof-of-Stake system to secure additional services or protocols. This extends the value of staked assets, turning them into building blocks for other networks.

Restaking embodies the composability of DeFi, allowing assets to do more work while contributing to the broader ecosystem. It also aligns incentives for users and protocols, further enhancing the interconnected nature of decentralized finance.

RWA

"RWA" is an abbreviation for "Real World Assets", referring to traditional assets that exist outside the digital asset and cryptocurrency ecosystems. These assets include fiat currency, real estate, stocks, bonds, artworks, gold, etc. They can be digitized or tokenized and traded and managed on the blockchain. Through blockchain technology, RWAs have advantages such as high transparency, low transaction costs, and easy transferability.

DeFi is no longer confined to digital tokens; it is increasingly integrating Real-World Assets (RWA) like real estate, invoices, and commodities. Tokenizing these assets enables:

• Fractional Ownership: Users can own and trade fractions of high-value assets, making them more accessible.
• Liquidity for Illiquid Assets: Traditionally illiquid assets, such as invoices or real estate, can now be used as collateral in DeFi protocols.

DeFi has evolved from Uniswap’s AMMs and Compound’s governance tokens to multi-chain interoperability and real-world asset tokenization, building a financial ecosystem that is open, inclusive, and rapidly advancing. Looking ahead, DeFi will integrate more deeply with traditional finance, enabling tokenization of assets, decentralized identity, and under-collateralized loans, expanding access to global financial systems.

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