What are the advantages and disadvantages of DeFi?
What are the advantages of DeFi?
Decentralised Finance allows millions of people globally to participate in an ecosystem that is fueled by code and setting new standards for trust, opportunity and financial access. Popularised by Ethereum’s blockchain technology of smart contracts, it offers financial means without the need of a central intermediary such as a bank or broker. This provides the advantage of having a financial system that is permissionless and trustless. Being decentralised and mainly run on Ethereum, this takes away all oversight from institutions and dependency on central corporations that can impact on data, identity and storage and maximises autonomy. DeFi ensures that financial services are easily accessible to any individual using decentralised applications and services, with interoperability from blockchains providing flexible options for guaranteeing different types of third-party integrations.
Transparency has also become maximised in DeFi. Blockchains such as Ethereum’s ensure that every transaction and information about all activities is publicly broadcasted on the blockchain, verified by other users of the network. Cryptographic principles underpinning the blockchain ensure the documentation of information is only recorded once its authenticity has been verified. This means decentralised applications can provide due diligence and help users identify and steer clear of financial scams, hacks and phishing as well as providing audit trails for transactions and financial activities.
DeFi has also paved the way for decentralised platforms such as derivatives, lending and borrowing, payments, management of assets and decentralised exchanges. All of these platforms are born from the alternative technology DeFi provides, with smart contracts performing specific actions only when certain conditions are met. DApps provide the ability to interact with these platforms, enabling two parties to directly and safely transact with one another without the need of a central intermediary. As a result, this provides further access globally to a lot more people, with lower costs and interest rates otherwise provided by traditional institutions.
What are some disadvantages of DeFi?
Although DeFi has a number of advantages, it has a number of drawbacks that are mainly related to blockchain technology. For instance, the shared responsibility factor works negatively for those individuals who use dApps. DApps do not take responsibility for a user misplacing their passwords, keys or logins as decentralisation eliminates the need for a central intermediary who oversees an individual’s assets and funds. Responsibility is transferred from intermediary to users. This means there is a lack of insurance in the event of a hack or other fraudulent activity and can leave users empty handed if mistakes are made via human error.
Furthermore, a lack of oversight means there is inherent risk with regulations. Central intermediaries such as the Government or ASIC provide regulation of financial markets and protect consumers and also enforce antitrust law. In America it is the SEC and Whilst these intermediaries are far from perfect, they provide a safety net for consumers by creating a fairer economy and marketplace. Another inherent risk of blockchain and cryptocurrency that pertains to decentralised finance is volatility and risk. Due to the youthful state of this industry, the value of cryptocurrency and DeFi projects is very difficult to ascertain. The cryptocurrency market is often very volatile, with assets having the ability to drop as much as 10% in a day.
Another disadvantage of decentralised finance is scalability of the host blockchain, with DeFi projects being suitable for a broader financial inclusion, however having difficulties with transaction speeds. DeFi transactions have been known to require long extended periods of time for confirmation and become extremely expensive at times of congestion, i.e. Ethereum ‘gas’ fees.