Decentralized Finance (DeFi) has been the latest buzzword in the crypto industry for some time, and its adoption has been increasing steadily, with more than US$1 billion worth of ETH locked in DeFi on the Ethereum platform. While many following the news have heard of DeFi, not many know what it entails, and how is it different from the traditional finance industry which has existed for more than a century?
In traditional finance, or Centralized Finance, people hand control over their assets to banks and other financial firms so professional managers can utilize the fund wisely in the markets. Their logic is that they will make higher returns than the average person and therefore, those who invested their money would also benefit.
However, the main problem is that having a centralized system means the risk is also concentrated at the centre. While bankers may be qualified and experienced, they are not flawless and are often prone to errors. Take the 2008 Global Financial Crisis for example, which stemmed from the US housing bubble. When they control all the money, we are allowing risk to accumulate at the centre, which poses a threat to the entire system.
On the other hand, Decentralized Finance means that people retain ownership of their assets and have full autonomy over them, as opposed to transferring it to the central system and allowing them to make decisions on your behalf.
Taking this into account, DeFi solves the fundamental problem associated with the traditional finance industry, while increasing its efficiency.
In addition, there are various advantages of adopting DeFi, namely:
- Decentralization allows for censorship resistance,
- Freedom to participate regardless of social standing or income
- Relatively speedy and low-cost transactions
- Users remains in possession of private keys
- Increased transparency of ecosystem, allowing for higher market efficiencies
Of course, DeFi is not without its shortcomings. In its current state, it is vulnerable to attacks and glitches, as seen in the bZx flash loan attacks on February of 2020. Moreover, most DeFi projects on the Ethereum platform aren’t well suited for high-frequency trading since they’re limited in terms of computational speed.
According to Haseeb Qureshi, a managing partner at Dragonfly Capital, the Ethereum network is a pretty lousy “world computer”. Qureshi took to Twitter to demonstrate that the network is actually slower than a 30-year-old calculator.
Furthermore, there is the problem of user adoption. A lack of awareness and knowledge amongst the general public, compounded by the fact that most DeFi applications have complex and confusing user interfaces, means that adoption will not come flooding in.
Being a nascent industry, it has much to learn and explore if it is to scale up and potentially take over the financial industry in the future. However, its future looks promising, and with various governments seriously looking into the potential of Blockchain and Crypto, we can be sure to hear more of it in the years to come.
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