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Blockchain, cryptocurrencies, and decentralization have promised a lot. Ever since their advent, the digital world has witnessed revolutionary changes in the diverse array of industries where businesses have adopted these technologies realizing their potential and future capabilities. One of their capabilities is DeFi.
The name “Decentralized Finance” (DeFi) indicates that it works on a decentralized approach to managing financial assets. DeFi refers to financial services that operate entirely on blockchain networks, eliminating intermediaries and enhancing transactional security.
Unlike the traditional banking system where a bank lends a loan as per the collateral at a specific interest rate and acts as an intermediary to process and control your money, Decentralized Finance systems run this arrangement by rethinking financial services, eliminating the middlemen, and assorting blockchain-based applications that offer peer-to-peer alternatives for conventional banking/financial services.
In DeFi you can get a loan simply by putting cryptocurrency up as collateral. This creates a smart contract that helps find you money from people who made a pool of funds available on the blockchain.
The smart contract documents your loan agreement, monitors transactions, and releases collateral upon full repayment as per the digital contract. There are other services offered by DeFi platforms like payments, insurance, investments, asset management, decentralized exchanges, flash loans, etc.
Well, the advancements in blockchain technology and its aspects like DeFi are expanding with leaps and bounds, there are both benefits and risks related to the decentralization of financial systems which cannot be ignored. Let’s take a look at both.
Benefits of Decentralized Finance (DeFi)
Blockchain finances are born from the promise of creating an alternative to the traditional financial market, where money is guarded by institutions and arbitrations ruled by courts. The figure of the intermediary is fundamental in the functioning of traditional finances, and users need to trust them when using the services.
The idea of the DeFi ecosystem, starting with proposals such as Bitcoin, is to eliminate the figure of the intermediary and thus provide greater security and efficiency to its users.
Each individual has control over their funds, as well as is responsible for securing and managing them at their convenience. The introduction of programmed finance, executed by code, increases transparency, decreases the possibilities of censorship, and limits the power of institutions. In this way, greater economic independence and a less manipulable market are promised.
Risks Associated with Decentralized Finance
The Preferred Target of Hackers
DeFi applications can handle a lot of money in their smart contracts. This makes them a target of interest to cybercriminals, who are on the trail of businesses vulnerable to inadvertent attacks. If a platform is released without auditing, with poor security or programming issues, it could experience massive token theft.
Inadvertent or Intentional Coding Errors
Decentralized finance applications rely heavily on the codes that make them. Smart contracts make it possible to execute vital operations for these platforms, such as money transfers, token custody, or credit settlement.
An error in coding a smart contract could lock up customer tokens with no possible solutions. Also, malicious entities that try to game the ecosystem could use their contracts and the inexperience of users, to steal money from customers without being noticed.
Some DeFi platforms have their decentralized governance systems, which allow users to vote on decisions that will affect the community, add new features, or change protocol regulations. These are participatory democracies, where anyone who has tenures on the said platform can assert their voice.
However, like any democracy, there may be certain problems that undermine the proper functioning of these governments. Whether it is a group of malicious users, a faction that wants to take complete power of the application, or internal bribery, some decisions can potentially affect the nature of the protocol, even endangering the funds of its users.
Lack of Knowledge
DeFi applications are programmable finance. This means that technical skills such as coding are vital to a good understanding of these platforms. Also, because blockchain networks and cryptocurrencies are fairly new technologies, this adds a new layer of complexity when it comes to a user interacting and understanding the functioning of the ecosystem.
The lack of knowledge when using a DeFi application can be fatal not only due to errors in use but could condemn a user to use a tool that has been poorly designed and coded. Whoever does not know about how a smart contract has been created, or if it does not have coding errors, could be depositing their money in an application that sooner or later will collapse with all their funds inside.
DeFi Is Being Used For Good!
Analyzing the advantages and disadvantages of DeFi, its development, and its regulation is questioned often; nonetheless, many realize its potential and strive to put it to great use.
DeFi can augment financial services and can transform the conventional benchmarks of the financial system. The adoption of DeFi is powered by the omnipresent nature of blockchain. We at CodeGlo accommodate experts that understand the rules and regulations of handling blockchain products closely and carefully.
We offer Blockchain Services that help you build digital products that are potentially rewarding in the market. To know more, get in touch with us anytime.