DeFi is a part of finance that is constantly expanding. We analyze this alternative blockchain-based economic ecosystem’s advantages and disadvantages.
DeFi, a mashup of “decentralized” and “financial,” has gained popularity in the blockchain and web3 communities. Decentralized money is a goal of Bitcoin and the other blockchains that came after it (via cryptocurrency). By decentralizing borrowing, lending, trading, remittances, and other services typically provided by credit unions, banks, and other established organizations, DeFi seeks to go beyond simply decentralizing money.
Decentralized applications (dApps) employ blockchain protocols to decentralize the same services as financial technology (FinTech) apps (Venmo, Revolut, Paypal, Robinhood), which are more closely connected to TradFi than DeFi. Since decentralization is the key distinction between these financial systems, we’ll be concentrating on it (the “De” in “DeFi”). Let’s look at some of DeFi’s advantages first.
Permissionlessness, which enables you to interact with DeFi without needing authorization to send remittances, apply for loans, or make online payments, is seen by many as one of its primary benefits. You require authorization from a bank or the aforementioned FinTech applications in order to utilize or access their services. You might need to supply personal information, go through rigorous Know-Your-Customer (KYC) checks, or offer proof that your finances and credit history can meet the standards for receiving a loan, depending on the demands you have.
On the contrary, anyone with access to the internet, a cryptocurrency wallet, and a smartphone may use DeFi alternatives to these services (or a computer). This enables you to transfer payments to anybody on the globe without their consent via a number of different blockchain technologies. These payments might be large or little (such as purchasing a house or a cup of coffee), local or worldwide, and they are frequently far less expensive than remittances and other antiquated options.
This permissionless doesn’t appear relevant until your permissions have been withdrawn, as seen by the capital controls in Iran, the prohibition of USD in Venezuela, the debanking of Canadian demonstrators, and many other cases. Having a DeFi alternative has been a financial lifeline for people who have been restricted or outlawed by the conventional banking system and are the victims of financial censorship.
Furthermore, both borrowing and lending are included under this permissionless policy. You can obtain a loan without a bank if you have cryptocurrency. You may use the DeFi protocol to deposit your cryptocurrency and receive an instant loan with crypto collateral that you can receive in stablecoins (which can be exchanged for fiat currency if needed). You instantly receive your cryptocurrency back when the loan is paid back. Additionally, if you so want, you may lend out your cryptocurrency to earn interest, letting you to serve as another person’s banking option. These DeFi rates are frequently substantially greater (1-10%+ vs. 0.01-1%, respectively) than the rates one would get from a typical savings account.
Finally, you may exchange your cryptocurrency permissionlessly through a decentralized exchange (DEX) for stablecoins and other cryptocurrencies. In striking contrast, during the GME short squeeze of 2021, the permissioned FinTech app Robinhood ended up revoking your access to purchase Gamestop shares. Many were inspired by this initiative to look into blockchain and DeFi alternatives.
DeFi permits anonymous or fictitious financial transactions via the internet. Online financial privacy is seen as a crucial human right by supporters. DeFi gives people complete control over their funds as an alternative to fiat and conventional payment networks. DeFi technologies frequently provide quicker and less expensive payments (and better lending and borrowing rates). A bitcoin payment often just takes a few seconds to a few minutes, in contrast to the days that a traditional transfer might take.
This permissionless function makes censorship resistance possible. Financial censorship controls are greatly reduced and less enforced since obtaining consent from a third party is not necessary. DeFi is enabling the unrestricted movement of cash throughout the globe as a workaround to stringent legal restrictions and frequently onerous financial punishments. DeFi’s resilience to censorship extends beyond what some would perceive as nefarious restrictions by financial institutions or governments and permits strong payment networks with little to no downtime (depending on the blockchain). Even big credit card networks occasionally have failures that can have a disastrous effect on developed regions and economies that depend on online payment capabilities or avoid using cash for transactions.
The last major advantage of DeFi is trustlessness, which means you don’t have to depend on anyone or any organization to look after your money. The blockchain makes this feasible. Starting with the fact that confirmed crypto transactions are immutable (irreversible and unchangeable), retailers don’t need to be concerned about a client canceling or postponing a payment. More crucially, DeFi protocols provide you complete control over your assets, eliminating the need to rely on a financial custodian or intermediary. This eliminates the counterparty risk that has affected TradFi (the Bernie Madoff Ponzi scam, the Cyprus bank account tax), as well as centralized crypto exchanges (CEXs), services, and products (FTX, BlockFi, Gemini Earn). The saying “not your (private) keys, not your coins” has become a mantra among crypto natives due to this third-party vulnerability. “If you have your keys, you have your coins,” says DeFi. This implies that you retain complete control over your cryptocurrency money; no one else has access to them.
The DeFi ecosystem’s ability to provide folks in underdeveloped areas or developing nations with access to essential financial services is yet another noteworthy advantage. One reason why millions of people worldwide still live in mostly cash-only economies is the lack of financial infrastructure—or the accessibility to it—in poor nations. Others might not have the minimum deposit necessary to create a bank account or could be reluctant to use them for a variety of other reasons.
The unbanked may now access crypto payments, crypto savings accounts, collateralized loans, and other DeFi goods thanks to DeFi solutions. With the help of these ground-breaking innovations, the unbanked may go directly from “cash economies” to “DeFi economies,” much as how many people transitioned from “no phone” to “mobile phone” without the need for an intermediary landline—and the associated infrastructure.
DeFi is basically a different financial option or alternative for the industrialized globe and banking populace. This may enable you to benefit from the above-mentioned DeFi advantages or encourage the TradFi and FinTech ecosystems to provide better rates, cheaper fees, and better service in order to remain competitive and win over new clients.
By substituting DeFi alternatives for these services (in part or whole), these people are “unbanking” themselves. DeFi is only an additional paradigm that may be utilized in conjunction with TradFi and FinTech products for many people who already have access to bank accounts, stock market access, and FinTech applications.
Every cryptocurrency has two sides (just like every block has six), and some people may have a different perspective and argue that some of the aforementioned benefits are really drawbacks. While DeFi gives you a lot of financial autonomy, it also comes with hazards and demands greater personal accountability.
Some people complain that using DeFi requires specialized crypto expertise or is simple to use. Despite improvements, DeFi frequently lacks dApps that can compete with the user-friendly user interfaces (UIs) and straightforward user experiences (UX) of FinTech applications and other financial products. This may raise the entrance hurdle, discouraging new users from utilizing DeFi devices.
Transactions’ immutability and irreversibility can lead to issues as well as monetary losses. It’s probable that you may lose the cryptocurrency in a transaction if you sent it to the incorrect address (unless the receiver chose to voluntarily return the crypto). On the other hand, you may frequently get a bad or fraudulent transaction reversed by your bank, credit union, or financial app. One of the reasons many people are hesitant to work with DeFi is the absence of a financial safety net for errors.
DeFi permits the potential for crypto losses due to self-custody mistakes. While “not your keys, not your money” refers to the safe storage of your cryptocurrency in one or more of your individual crypto wallets, the converse is also true: “lose your keys, lose your coins.” You will lose all the cryptocurrency saved on your wallet if you don’t have recovery mechanisms in place (a secondary wallet backup or a recovery phrase) and you lose your wallet or forget its access password. Heavy financial losses can be caused by unintentionally misdirected transactions and unrecoverable cryptocurrency wallets, which have led to horror stories for individuals impacted. Losing access to your bank or stock holdings permanently is far difficult to do, if not almost impossible.
Illegal activity can be stopped by identifying financial parties and their transactions. While some people applaud DeFi’s permissionlessness, others are alarmed by the absence of KYC and anti-money-laundering (AML) protocols in some DeFi communities. This could lead to unlawful behaviors that might otherwise be stopped, such as tax evasion and human trafficking. DeFi backers argue that the majority of these illegal operations still involve TradFi-enabled fiat transfers.
The last danger is the potential for a dApp or DeFi protocol compromise or smart contract exploit. There is still a chance that you might lose cryptocurrency using DeFi even if you don’t make an error in judgment with a transaction or lose your cryptocurrency wallet (and its contents). A black hat hacker might steal cryptocurrency if you transmit it from your wallet to a DeFi project by taking advantage of a flaw in the protocol, a cross-chain bridge, or another DeFi attack. The DAO attack, the Ronin bridge exploit, and the Wormhole event are notable instances.It is advised for individuals who use DeFi to choose DeFi devices that are well-known and have been in existence for a while, as the likelihood of a hack being successfully carried out typically tends to decrease over time.
A DEX like Uniswap, Ox Protocol, or QuickSwap would be a good place to start if you wanted to test the waters in this developing industry. After that, you might want to look into DeFi solutions with more features, including Lido, Aave, Curve, or Compound. They provide you the chance to experience with DeFi’s lending, borrowing, and staking possibilities.
Although most people would agree that DeFi has both advantages and disadvantages, attitudes might differ widely depending on one’s philosophical or political views. The need and benefits of KYC, AML, reputable financial institutions, and having some type of remedy in the case of a financially related hack, fraud, or other issue are often argued by those who are more conventional or come from the TradFi environment. DeFi is the answer to counterparty risk, financial middlemen, unbanked people, the desire to remain anonymous, financial censorship, and the friction and delays associated with traditional banking for the crypto native community. For these reasons, it is usually best left up to the individual, their particular circumstances, and their overall viewpoint whether they choose to remain rooted in TradFi, explore DeFi, or employ a blend of these several financial realms.