Where dose Advantages of DeFi?
1. Bye-Bye to human error and mismanagement
We have already mentioned that financial crises occurred due to the mismanagement of central banks(CBs) and third party intermediaries (TPIs). But thanks to smart contracts applied in DeFi, human error on a day-to-day basis are removed from the process; unless the contracts themselves were poorly written.
2. Quick and permanent access
Before DeFi, if you needed to get a loan, you would have to go to bank and a lot of time will be wasted.
With DeFi, you can get a loan with just one click, even in the middle of the night. You can access the market from anywhere and anytime as long as you have an internet connection.
3. A Healthier System
COVID-19 has shown that traditional financial systems (CeFi) are very vulnerable to global shocks. This is because centralized financial systems are based on direct contact between individuals.
According to the economist Nariman Behravesh, COVID-19 has caused an economic shock three times worse than the 2008 financial crisis.
The level of physical contact needed to support decentralized financial systems (DeFi) could drop to zero; and cryptocurrency prices and companies have been going from strength to strength in the current health crisis.
4. Permissionless Operations
In the traditional financial system, you have to get permission from an intermediary to carry out almost any financial operation.
To withdraw a penny from your account, you must wait for bank approval, while DeFi users can interact with financial services without permission
A wide range of services could be imagined in DeFi space, that not all of them could be mentioned in this discussion. However, whether all of these services and platforms risk-free?
Undoubtedly, the answer is “No”. Just like an apple that may contain a worm, a DeFi products have their own problems and risks.
What are the challenges facing DeFi projects?
Many of the problems and risks facing a DeFi project are related to the technology they are built upon; blockchains themselves. Since over 90% of DeFi projects are based on Ethereum blockchain, we will consider the challenges for Ethereum challenges as DeFi challenges:
1. Uncertaintity
If the blockchain that hosts a DeFi project is unstable, the project spontaneously inherits this instability from the host blockchain. The Ethereum blockchain is still undergoing plenty of changes, for example mistakes made when moving from PoW to new ETH 2.0 PoS system could introduce new risks to DeFi projects.
2. Scalability
Another big problem with DeFi projects is scalability of the host blockchain.
Two major problems arise from the scalability problem:
a) transactions take a long time to be confirmed
b) transaction are extremely expensive at times of congestion
Ethereum at full capacity, can process about 13 transactions per second, while centralized counterparts can process thousands and thousands of transactions.
3. Smart Contract Problems
Smart contract vulnerability is a major source of issues for many DeFi projects. If there is the slightest flaw in the code of a smart contract, it can lead to loss of funds.
4. Low Liquidity
Liquidity can be considered as one of the most important factors for DeFi token-based projects and blockchain protocols. The total value locked in DeFi is over $12.5 billion by October 2020. This is a drop in the ocean when compared to the traditional financial systems.
5. Over-collateralization
As we previously said the crypto loan business is an attractive service in DeFi. But this business suffers from over-collateralization and it occurs when the value of the staked asset (by borrower) is prohibitively high when compared to the loan amount itself. DeFi projects have high collateralization in order to counter the removal of obstacles such as credit ratings.
6. Low Interoperability
There are different types of blockchains such as Bitcoin, Ethereum, Binance Smart Chain, each with its own DeFi ecosystem and community. Interoperability enables DeFi platforms, tools, DApps and smart contracts on different blockchains to interact with each other. Until this becomes simpler, many projects are siloed.
7. Lack of Insurance
Insurance protects investors in the event of a hacks or other fraudulent activities. Insurance plays a very important role in centralized finance while it is much more rare in DeFi.
8. Centralization
Creating a decentralized finance is the main purpose of creating bitcoin and blockchain, but sometimes decentralized finance isn’t as decentralized as it should be. Decentralization greatly reduces the possibility of scam.
“Sushiswap” was a DeFi project. The anonymous founder of Sushiswap has rug pulled the project converting all of his Sushi tokens to ETH on September 5, 2020. The price of SUSHI token went up in value to $10 after forked from the Uniswap protocol, and dropped to 0.6$ (at the time of writing this article) after founder converted his tokens. This was an example of how a single point of failure is possible even within DeFi.
9. Your Responsibility
Assuming that DeFi is free of risks and issues, it’s still not responsible for your mistakes. DeFi transfers responsibility from intermediaries to users. If you lose your funds by mistake no one will be responsible, hence, creating some tools to prevent human errors and mistakes is strongly needed in the DeFi space. With freedom comes a lot of responsibility, and many users are not used to having to take care of themselves in this way; which can lead to them losing funds or being scammed.
DeFi is new and experimental and has some issues and problems, especially in terms of security. Developers and fans of decentralized finance hope that these problems will eventually be solved.
