Crypto is getting a lot of attention, but another technology related to crypto is gaining popularity — DeFi (decentralized finance).
The new service allows users to access their money without giving up control over how they use it or without trusting third parties like banks with personal information. It also means there is no limit to what you can do with your funds. In short, it turns cryptocurrencies into everyday transaction currencies. So far so good? Not quite yet…
Problems with Celsius: Problems with “CeDeFi”
Currently the most popular example of DeFi is Celsius from Celesius Inc. based in San Francisco, which launched its main network less than two months ago. Although the app itself is not complicated, some people have criticized the project for being too similar to other “stablecoin” projects such as MakerDAO. Stablecoins are digital tokens tied 1:1 to real assets such as dollars or euros. This design choice makes them resistant to price volatility caused by high trading volumes. But critics say that while stablecoins may be more reliable than traditional currency, this approach does not solve the centralization problems inherent in fiat banking systems. Some even argue that these coins could become just another tool for large financial institutions to extract value at the expense of regular customers.
So why would anyone want to use DeFi? Well, many believe that DeFi offers significantly improved privacy, security, reliability, speed, cost-effectiveness, affordability, transparency, accountability and user experience compared to existing payment solutions. Here’s an analysis of how DeFi and CeFi stack up when these features are taken into account.
DeFi vs. CeFi: Comparing Decentralized and Centralized Finance
Decentralized financial platforms offer several advantages over their centralized counterparts. For example, they allow users to avoid censorship and surveillance attacks by government agencies. Furthermore, because blockchain technology enables data integrity and immutability, records cannot be altered once they are created. Unlike conventional organizations, where employees can make mistakes due to human error and lack of oversight, blockchains guarantee accuracy through cryptography and self-regulation.
In addition, DeFi networks are usually run directly by community members, who receive rewards for helping the network run smoothly. Finally, unlike big companies, DeFi platforms work 24/7 and never shut down.
While all major DeFi services currently operate online, only one in three DeFi applications —
MakerDAO – Dai — is open source. Open Source Software | Open Source Development Foundation
In terms of centralized finance, modern bank accounts provide convenient ways to send payments between individuals and businesses around the world. However, banks charge fees to access their services and may freeze your account if you do not meet certain conditions. Moreover, centralized institutions have limited possibilities to resolve disputes or implement changes in contracts with users. They also give clients little power to influence the decisions made by financial managers.
Another disadvantage of using a regulated financial institution is that it ties your wealth to the performance of said entity. If the latter fails, you’re stuck with any losses incurred. On top of that, there’s always the chance that regulators will decide to confiscate your savings and impose restrictions on future transactions. After all, regulatory compliance standards differ between regions, meaning your local bank may be perfectly legal in one country but illegal in yours.
DeFi risks and the illusion of decentralization
According to research conducted by the Wall Street Journal, about $2 trillion in consumer debt is uncollected in US federal courts. That number alone should dispel the idea that we live in a post-financial crisis world. Unfortunately, the same report found that nearly half of Americans mistakenly believe that central bodies like governments and big tech companies play an active role in protecting consumers’ personal finances. Really, many people mistakenly assume that DeFi works similarly to centralized finance. However, this view could not be further from the truth.
Negative effects of DeFi
On the other hand, DeFi still suffers from several shortcomings and challenges unique to new technologies. First, due to the early stage of the industry, DeFi protocols often do not support every feature required by end users. Second, although many DeFi platforms are equipped with built-in mechanisms designed to prevent fraud and theft, they can fall victim to hacking and fraud by malicious actors. And finally, while DeFi provides greater flexibility and freedom for users, they typically require higher levels of technical expertise to set up properly.
DeFi is “trustless”
First, DeFi does not rely on trusted intermediaries or gatekeepers acting as intermediaries. Instead, it uses smart contracts written specifically for each transaction performed on it. As such, DeFi providers must provide liquidity before opening the market for trading. Otherwise, users could get burned trying to exit positions prematurely. Also, since the DeFi apps themselves are open source, developers can audit their own software to confirm that everything is running smoothly. Consequently, they can fix bugs faster than centralized organizations.
Second, thanks to transparent reporting and public audit tools, DeFi users enjoy unprecedented control over their finances. Users can easily verify that their wallet actually contains the amount of funds they have deposited. At the same time, blockchain explorers allow participants to see details of individual transactions including amounts sent and received, fuel prices, contract hashes, etc. All this information is publicly available via API, making it easier to create competitive DeFi-based products and services protocol.
Third, despite fewer resources, smaller teams and shorter product development timelines, successful startups behind leading DeFi platforms regularly outperform established global conglomerates in terms of profitability and growth rates. For example, according to Coin Market Cap, Binance Labs recently became TrustToken’s largest shareholder after acquiring a 72% stake during the third quarter of 2021. Meanwhile, Visa was ranked 11th among Ethereum Classic’s largest corporate owners last year. Fourth, DeFi users benefit from lower costs associated with capital expenditures required to build infrastructure. Since DeFi service providers do not depend on external sources of funding, they do not need expensive office buildings, servers and IT staff salaries. Instead, they invest solely in maintaining the basic functionality of the platform.
Finally, owners of DeFi applications retain ownership of their assets forever. Neither party controls access to sensitive metadata related to user identities and states. Therefore, they will not face the problems with identity verification and KYC procedures common to legacy banking systems.
Finally, while DeFi protocols promise convenience and autonomy, they still require extensive training and education to understand how they work properly. Many newcomers to DeFi prefer learning about the nuances of blockchain rather than understanding complex concepts like collateralization and over-collateralization versus fractional reserves.
Despite its limitations, DeFi appears poised to disrupt legacy funding models. However, the success of the former depends on the ability of regulators to adapt quickly enough to mitigate the potential threats posed by innovative DeFi innovations. While a handful of jurisdictions are taking steps toward regulating DeFi, others are still lagging behind. In fact, after a series of scandals involving Facebook’s Libra coin, US lawmakers have introduced legislation aimed at preventing Facebook from launching any digital assets until regulations are in place.
It remains unclear whether government policymakers will end up embracing DeFi innovation by embracing regulation or vice versa. There is certainly room for improvement in terms of policy making surrounding space. It is possible to start and learn crypto today. https://cryptocrooks.com/best-crypto-products/
Disclaimer: The information contained herein is provided without consideration of your personal circumstances and should therefore not be construed as financial advice, an investment recommendation or an offer or solicitation of any cryptocurrency transactions.