How will DeFi change finance?
Decentralized finance (DeFi) is an emerging financial technology that challenges the current centralized banking system. DeFi attempts to eliminate the fees that banks and other financial service companies charge while promoting peer-to-peer transactions.
One of the most significant impacts of DeFi is disintermediation. By removing intermediaries from financial transactions, DeFi empowers individuals to have full control over their assets, eliminating the need to rely on traditional financial institutions.
Meanwhile, DeFi leverages the power of Blockchain's transparency and decentralization to eliminate these intermediaries. Specifically: Governments or banks (CeFi) will be replaced by decentralized blockchains. CeFi assets will be replaced by tokens located in the Blockchain ecosystem and they are decentralized.
In attempting to replicate some of the functions of the traditional financial system, DeFi inherits and may amplify the vulnerabilities of that system. This includes well-known vulnerabilities such as operational fragilities, liquidity and maturity mismatches, leverage, and interconnectedness.
Optimism abounds as the green shoots of renewed growth begin to show. Julian Deschler, co-founder of Web3 privacy protocol Elusiv, is among the leaders who are bullish on DeFi's prospects in the near term. “We look forward to a resurgence of constructive growth in the DeFi ecosystem.
The short answer is yes, decentralized finance (DeFi) can replace banks and conventional financial systems. Cryptocurrency may readily replace cash as a store of wealth, medium of trade, and unit of account.
DeFi could also lead to digitizing traditional bank functions like lending, borrowing, and saving. Smart contracts can lend funds based on criteria written into the code. They can also facilitate deposits and make interest payments without human intervention.
DeFi's vulnerabilities are severe because of high leverage, liquidity mismatches, built-in interconnectedness and the lack of shock-absorbing capacity. The term DeFi refers to the financial applications run by smart contracts on a blockchain, typically a permissionless (ie public) chain.
Because DeFi transactions are recorded on a decentralized blockchain, they are resistant to hacking and other forms of fraud. In contrast, traditional finance systems are often vulnerable to cyber attacks and other forms of security breaches. Thirdly, DeFi offers greater accessibility.
DeFi can disrupt traditional financial structures. DEX provides a marketplace for peer-to-peer transactions between cryptotraders, where there is no intermediary involved. In 2021 alone, DEXs executed more than $1 trillion Opens in new tab in trading volumes.
What is the dark side of DeFi?
However, with the rise of decentralized finance comes a dark side known as rug pulls. Rug pulls occur when developers or liquidity providers suddenly abandon a project, taking all the invested funds with them. This malicious act leaves investors empty-handed and erodes trust in the DeFi ecosystem.
Another major disadvantage of DeFi is the high number of risks associated with it. These include market volatility, smart contract failures, and hacking threats. Moreover, unlike traditional banking systems which offer insurance and consumer protection mechanisms, such safeguards are typically absent in the DeFi space.
Though illicit actors are becoming more sophisticated in their efforts to launder cryptoassets through the world of DeFi, the transparency of the blockchain offers compliance teams at VASPs and financial institutions the ability to identify funds associated with DeFi-related laundering.
The global decentralized finance (DeFi) market is expected to be worth $232.20 billion by the end of 2030, up from an estimated $11.96 billion in 2021. The market report is an important guide to growth factors, challenges, barriers, and opportunities in the global market.
Revenue in the DeFi market is projected to reach US$26,170.0m in 2024. Revenue is expected to show an annual growth rate (CAGR 2024-2028) of 9.07% resulting in a projected total amount of US$37,040.0m by 2028. The average revenue per user in the DeFi market amounts to US$1,378.0 in 2024.
On February 4, 2004, a dorm room project was born and became a $1 trillion company with 3 billion users in 2021 — it is called Facebook, or Meta after rebranding. DeFi has just started, and with the resources and talent flowing into the space now, growing 100x in the next 5 years is not a dream, it is inevitable.
DeFi uses several progressive and flexible tools to put users in control. The fact that the new trend provides additional functionality while reducing operational risk makes it a perfect replacement for the current financial system.
Central bank digital currencies (CBDC) can replace physical money, especially in economies where cash deployment is costly, Managing Director of the International Monetary Fund Kristalina Georgieva said during a Wednesday speech.
Hacks are an ever-present technology risk for DeFi users. While smart contract risk is an inevitable DeFi technology risk, there are some ways to mitigate it. Extensive testing and code audits, for instance, can reveal some bugs before the code is released to the mainnet.
Liquidations is one of the fundamental risks in DeFi lending protocols. Users in DeFi wallets, exchanges or DApps participating in DeFi lending protocols often incurred a somewhat invisible liquidation risk. Every day, there are millions of dollars lost to liquidations in DeFi loans.
Who benefits from DeFi?
One of the most significant advantages of DeFi is its accessibility. As a permissionless and open-source system, it provides financial services to anyone with an internet connection, irrespective of their geopolitical location.
The Risks of DeFi Lending
There are 4 popular risks associated to DeFi lending. Cryptocurrencies are known for their rapid value fluctuations. If the value of the collateral falls below a set threshold, smart contracts automatically liquidate it, leading to the borrower losing their investment.
1. Smart contract flaws. Faulty smart contracts are among the most common risks of DeFi. Malicious actors eager to steal users' funds can exploit smart contracts that have weak coding. Most decentralized exchanges enable trading through the use of liquidity pools.
How to avoid it: If you are swapping an illiquid token, the only thing that can be done to minimize negative price impact is to reduce the amount swapped. As a courtesy, 1inch provides a warning that will show how much you will lose (in percentage terms) to price impact before you make the swap.
DeFi hacking exploded in 2021 and 2022, with attackers stealing approximately $2.5 billion and $3.1 billion, respectively, from protocols.
