Decentralized finance (DeFi), a word that was first used in the year 2018, increased the potential of blockchain technology and cryptocurrencies by taking use of the 'smart contracts' functionality offered by the Ethereum blockchain network.
DeFi has been hailed as the revolutionary financial system that is open, borderless, and empowers people to interact directly with one another using cryptocurrency.
Traditional finance now uses a network of banks, central institutions, and numerous intermediaries.
Nevertheless, despite the numerous advantages that DeFi provides, it also poses a distinctive set of risks and obstacles that continue to split financial professionals over the long-term viability of this decentralized global financial system that is currently expanding quickly.
Benefits of DeFi
Imagine a financial system where the user's primary duty is to maintain control over their money and the confidentiality of their transactions.
DeFi has achieved this by utilizing cryptocurrencies to power transactions throughout the world at a breakneck velocity, executing transactions between users via smart contracts, and facilitating borrowing or lending.
DeFi offers the highest level of security because to the immutable transaction capacity provided by blockchain technology, which eliminates the need for central banks to control all of this activity.
In other words, by using cryptocurrencies for transactions, DeFi eliminates the drawbacks of conventional financing and opens up a new universe of opportunities for cryptocurrency users.
Furthermore, by allowing anybody to engage in the global economy through the internet and depending on the user community to vote on governance issues of the numerous DeFi initiatives already in existence, it democratizes finance.
Issues affecting the DeFi sector
DeFi has faced difficulties that might impede its worldwide spread, as is the case with every new technology advancement.
In a fast-growing DeFi field where dozens of blockchain startups are competing for consumers and market share, there have been more incidents of dishonest operators stealing investor money and fleeing with it.
Cybercriminals have also been concentrating on projects with potential security flaws as a result of all transactions taking place online and have continued to target consumers who aren't as cautious with their crypto holdings.
These hostile parties were able to steal a record $14 billion in 2021, according to blockchain analytics company Chainalysis, with a large portion of these assets coming from DeFi initiatives or their users.
The DeFi sector and the larger crypto community, on the other hand, are constantly developing new strategies to lessen the vulnerability of smart contracts and adopt a self-regulatory framework that is designed to prevent such attacks, thereby boosting investor confidence in this ground-breaking financial system.
Regulatory burdens are a potential hazard
Given the aforementioned issues and the threat it poses to the current global financial system, it is no surprise that governments all over the globe are concerned about the emergence of DeFi.
One only needs to look at what the US Federal Reserve did when the COVID-19 outbreak started to have an idea of the latter background.
In an effort to support the domestic economy, the central bank began printing billions of dollars to buy corporate bonds and maintain overall interest rates at multi-year lows.
But even then, this has fueled rampant inflation, and as a result, the US economy is now facing an impending recession.
DeFi, in contrast, operates independently of the US Federal Reserve and all other central banks, giving citizens a degree of non-interference that allows market forces to steer the direction of the world economy.
Instead of being susceptible to sudden interest rate adjustments as is the case with central banks throughout the world, it gives crypto holders control over the APYs on offer and the borrowing interest rates that apply.
However, with most developing countries worried about the transfer of value from traditional financial systems to DeFi, a number of debilitating regulations are being planned that threaten to cripple the blossoming DeFi space.
While the narrative maintained states that these regulations are meant to safeguard investor interests, a closer look at proposed draft regulations lays bare the sinister intentions of curtailing or restricting innovation in the DeFi space.
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First Published:
15 Aug 2022, 12:50 PM IST
