The advantages and hazards of decentralized finance
Cryptocurrency and the blockchains that power them have many promises made by ardent proponents. For them, these technologies provide relief from corporate control of the internet, governmental restrictions on liberty, poverty, and almost all other social ills. The reality, however, has largely entailed financial speculating using well-known cryptocurrencies like bitcoin and dogecoin, which soar and tumble with frightening regularity. What are the benefits of blockchain and cryptocurrency then? DeFi, or decentralized finance, is the first convincing response to that query. DeFi describes financial services that run solely over blockchain networks as opposed to using middlemen like banks. The bank controls your money and sits in the center of the transaction, therefore everything depends on it. The same holds true for today’s stock trading, asset management, insurance, and pretty much all financial services. Banks continue to serve as the intermediary even when a financial technology tool like Chime, Affirm, or Robinhood streamlines the procedure. This increases lending costs and reduces borrower flexibility. By reimagining financial services as decentralized software apps that function without ever taking possession of customer dollars, DeFi flips this system on its head. Desire a loan? By just putting bitcoin up as collateral, you might obtain one right away. By doing this, a “smart contract” is created that locates your money within a pool of cash made accessible on the blockchain by other users. Bank loan officers are not required. Everything is powered by so-called stablecoins, which are currency-like tokens that are often anchored to the US dollar in order to mitigate the volatility of cryptocurrencies like bitcoin. Additionally, rather than a bank or other middlemen getting a share, transactions settle instantly on a blockchain, which is effectively a distributed digital database of transactions.
The risks: Blockchains cannot eliminate investment risks, which are a necessary consequence of the possibility of gains. In this situation, DeFi might increase the cryptocurrency market’s already high volatility. Leverage, in which investors basically borrow money to multiply their returns but incur greater risk of losses, is made possible by several DeFi platforms. Furthermore, no banking or regulator has the authority to return monies that were transferred inadvertently. In addition, investors may not always receive their money back if hackers discover a flaw in a DeFi service’s smart contracts or other components. In the last two years, around $300 million in thefts had occurred. The phrase “investor beware” is the main safeguard against unforeseen losses, yet it has never been sufficient in the world of finance. Some DeFi services appear to contravene legal requirements in the US and other countries, such as not prohibiting terrorists from transacting or enabling any member of the public to invest in derivatives or other banned assets. ever without conventional intermediates, it’s unclear how any of those rules might ever be applied in DeFi. The internet has consistently weakened the bottleneck power of middlemen, from travel agencies to automobile dealers. DeFi is just another illustration of how open-source software has the capacity to fundamentally alter the playing field. However, in order to fully grasp the promise of this new financial ecosystem, developers and regulators will need to improve their own performance.
The rewards: This allows for more automated, flexible, secure, and efficient transactions than are possible with traditional finance. Additionally, DeFi does away with the gap between common consumers and affluent people or institutions, who have access to a greater variety of financial goods. Anyone who wants to lend money to others can join a DeFi lending pool. Compared to a bond fund or certificate of deposit, the risk is higher, but so are the possible profits. And that’s only the start. DeFi services may be mixed and altered nearly endlessly since they are powered by open-source software. For instance, based on whatever collateral pool presently gives the highest returns for your investment profile, they can automatically swap your assets between them. As a result, the quick innovation witnessed in social media and e-commerce might replace the conventionally conservative financial services. These advantages provide some insight into why DeFi expansion has been so rapid. More than $80 billion worth of cryptocurrency were trapped in DeFi contracts at the most recent market top in May 2021, up from less than $1 billion the previous month. As of August 3, 2021, the market has a total value of $69 billion. Given that the $20 trillion global financial industry is only a drop in the ocean, there is clearly space for further expansion. The majority of customers right now are seasoned cryptocurrency traders, not the inexperienced amateurs that have flocked to websites like Robinhood. Only 1% of bitcoin owners have tried DeFi.
