Decentralized finance (DeFi) is an emerging trend disrupting the traditional financial sector. It's made up of a system of financial applications that operates on a decentralized blockchain network, offering financial services such as lending, borrowing, trading, and investment. Decentralized finance has been expanding rapidly, and it's becoming an essential part of the cryptocurrency ecosystem.
In this article, we will explain how big the DeFi market size actually is, talk about the core segments and metrics that make up Decentralized Finance and note the industry's primary growth drivers.
What is decentralized finance and how does it differ from “regular” finance?
Before we talk about the size of the DeFi market, we need to explain what it actually is.
As we've already mentioned, a big part of DeFi is the blockchain, or rather how closely its tied to it. The best way to understand how it functions is by being aware of how it differs from regular finance.
Simply put, it’s all in the name — Decentralized Finance. Instead of having your financial life revolve around the government and banks, it's all processed through the blockchain. DeFi supporters claim that instead of having your money handled by ineffectual, inefficient, and often corrupt government and bank officials, everything will be processed by the code inherent in the blockchain and within smart contracts.
Let's give a concrete example.
Let's say you want to borrow money. In regular finance, you would go to a bank or lender, fill out an application, and the lender would decide whether or not to approve your loan based on your credit history, income, and other factors. The bank would also charge you interest on the loan.
In contrast, first, you can go to a good crypto exchange. Then, using DeFi, you could borrow money (in the form of crypto, most often a stablecoin) directly from another individual without involving any intermediaries. You could put up cryptocurrency as collateral, and the loan terms would be enforced by smart contracts that automatically execute the loan agreement terms. You won't have to fill out an application, and the interest rates could be much lower than in traditional finance since no intermediaries are involved.
DeFi market size: Components, metrics, and growth drivers explained
Decentralized finance market size
Due to its very nature, the most common and precise way to measure the market size of decentralized finance is through two closely related metrics:
Total Value Locked (TVL)
Wallets in use
TVL is the amount of capital locked within DeFi protocols (more on both below). The capital is in the form of cryptocurrencies sent through crypto wallets.
Considering both metrics, the latest verifiable report notes that the DeFi market size was $213.98 billion in 2022.
DeFi market cap: Tokens and crypto market cap
The market capitalization of the DeFi segment of the crypto market is at $57,46 billion at the time of writing.
DeFi protocols and DeFi platforms
DeFi protocols are blockchain-based software applications that allow individuals to access financial services without the need for traditional intermediaries like banks or other financial institutions. These protocols use smart contracts to automate financial transactions, which are then recorded on a decentralized public ledger, providing stability to the DeFi market.
On the other hand, a DeFi platform is a user interface or a web application that provides access to one or more DeFi protocols. These platforms make it easy for users to interact with DeFi protocols by providing a user-friendly interface, displaying relevant information, and enabling transactions.
Basically, a DeFi protocol is the underlying technology that powers the DeFi ecosystem, while a DeFi platform is a user-facing application that allows users to interact with the DeFi protocols.
What is total value locked and why is it an important metric for market size and share?
Now, to explain the perhaps most important term needed to understand the growth of DeFi and the market in general.
Total Value Locked (TVL) in DeFi refers to the total amount of cryptocurrency assets currently used in decentralized finance applications. Basically, it is a measure of how much money can be found within DeFi protocols.
To give an example, imagine you have $1,000 worth of crypto, and you deposit it into a DeFi platform. Your $1,000 is now part of the TVL of that lending platform. Now imagine that hundreds or thousands of other people do the same thing, depositing their own cryptocurrency into the same DeFi platform. The TVL of that platform will increase as more and more people deposit their assets.
Smart contracts
Finally, a little bit about smart contracts.
Smart contracts are self-executing computer programs that automatically enforce the rules and regulations of a contract within decentralized finance. They are typically used in blockchain-based applications to facilitate and automate transactions without the need for intermediaries.
They are vital for DeFi market growth, as they provide protection to both sides of a given contract.
Here is an example of how a smart contract works:
Let's say that you want to rent a vacation home from a host, and you want to use a smart contract. You and the host would agree on the terms of the rental agreement, such as the price, dates of the rental, and any penalties for breaking the terms of the agreement.
This agreement would then be encoded into a smart contract, which would be deployed on a blockchain. The smart contract would contain the terms of the rental agreement and the rules for enforcing it.
When you send a payment to the smart contract, it would automatically execute the terms of the agreement. So, if you were supposed to have access to the home on a specific date and the host didn't provide access, the smart contract could automatically release a refund to you or impose a penalty on the host.
An algorithm-led economy
Decentralized finance has experienced rapid growth over the past few years, and the DeFi market size is continually expanding.
As more investors and institutions realize the potential of DeFi, they will continue to pour more funds into the space, driving its growth further. With the integration of DeFi into traditional finance, we can expect to see more adoption and mainstream acceptance of this innovative technology.
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