Blockchain has been the talk of the town for more than a decade now. A blockchain-supported financial ecosystem is said to give greater autonomy, more liquidity, higher security, and enhanced transparency. The job at hand is to create a user interface for all. For the banking sector, decentralized digital finance, or simply decentralized finance (DeFi) is a fast-growing implementation within blockchain.
The emergence of DeFi
As of August 2020, the total value locked in DeFi stands at $6.19 billion and DeFi assets have exponentially grown 20 folds as compared with that in February 2019. More than 0.04% of the total Ethereum supply is locked up in DeFi applications.
DeFi environments are global as there is no geographical limitation to access the networks and services. They are not centrally managed or operated by any institution or employee, the environments are transparent and entirely run and maintained by smart contracts and algorithms. They are also open source, meaning anyone can create decentralized applications (dApps) without any limitations. And all activities can be seen by each member, which makes the system auditable by any member, giving them the opportunity to understand the code’s functionalities.
The future of finance is being built around factors such as removing the middleman to decrease cost and increase resilience, decentralizing the authority to create autonomy, and creating a well distributed framework. Global crises like COVID-19 clearly define that when control is with only few actors, the risks are so great that they threaten entire systems, giving DeFi a chance to prove its worth.
DeFi has seen several types of implementations in the financial sector as it eases the way we handle money and improves financial security while enhancing liquidity. DeFi is challenging some top financial tools by providing use-cases like lending, decentralized exchanges (DEXs), derivatives, wallets, asset management, insurance, and savings.
Lending platforms on blockchain are one of the biggest and most highly implemented use-cases in DeFi. They use smart contracts to automate several rules and define limits, but they are still at a very early stage for mainstream use and to be acceptable to general users. These platforms are mainly being used by blockchain enthusiasts and crypto speculators as they currently fall within the “grey” regulation zone. To bring DeFi to the general public, they need to go under extensive penetration testing, protocol reliability testing, strength testing, and volume and scalability testing. These dApps can only be taken advantage of by the average users when the underlying technological vulnerabilities are resolved.
Issues and benefits
One of the major issues faced by DeFi and blockchain projects in terms of mass adoption is the complexity of their user interface (UI). In order to reach maximum users, these platforms need to simplify their UIs for mass adoption. As DeFi platforms are relatively new and immature, users who intend to invest their funds in these platforms must take into account the risks associated with them.
Even then, DeFi projects have a long-term scope with well-built features like higher transaction speed, eradication of centralized authority, easy accessibility, removal of any intermediaries and third parties making it cheaper and faster.
DeFi platforms have been a center of attention for hackers and have seen some major attacks, including on venture capital firms like Volt Capital, Paradigm Capital, and Collaborative Funds. Chinese DeFi protocol, dForce, lost around $25 million of its assets in an attack, which was later returned by the hackers. A similar attack was made on DAO in 2016.
Traditional financial institutes or centralized crypto exchanges have been subject to various hacker attacks over the years as well. To overcome the risk of attacks, some DeFi applications are not completely decentralized. They keep some operations controlled centrally like keeping the administrator private keys, etc.
While some of us want an upgrade in our financial systems, others wonder if the implementation of DeFi is going to make the system even more prone to errors and manipulation, giving way to lack of accountability. The question that arises is whether DeFi platforms can fix errors when something goes wrong, then how decentralized they actually are? Also, while decentralization and autonomy seem great, they too have their grey sides. If a person loses their password, private key, or their address, it can cost the user his/her entire investment. And smart contracts are pieces of codes that put all activities in place, so if one is hacked all data and funds of the platform could be compromised.
The complex concepts and working of DeFi call for specialized knowledge to handle its tools and operate apps. Steps are being taken by several organizations to educate people regarding the basics of blockchain and its operations.
DeFi’s aim is to construct a completely distinct financial ecosystem where no central authority has power, and which can be accessed by anyone from around the world. It will create an inter-protocol communication system to ensure interoperability. Post the pandemic, Defi will be able to show its full potential to radically transform the financial services industry.
By when is the next big question.
