The Risk and Rewards of DeFi
Bitcoin and other such cryptocurrencies run on blockchain technology. This technology enables a user to transfer these digital currencies directly to another user without any intervention from third parties such as banks or other financial organizations. In the centralized financial system, banks are the backbone of every transaction. Suppose you want to transfer money to another person, but without the approval of the bank, you won’t be able to transfer even a dollar. You may think that you can transfer cash person to person if you want to, but even then, you will have to withdraw the money from the bank, and the bank can stop at the initial step. Bank has the authority and control over your own money and assets.
But DeFi changes all this, in decentralized finance, there is no concept of a middle man or third party. Any transaction can be freely conducted within two parties or more, and that too without any transaction charges at all. DeFi operates purely on blockchain networks. Moreover, after the creation of smart contracts, DeFi has become more popular due to its auto operation and optimization technology. Using smart contracts, you won’t need to transfer money to another person manually. The code in the software has pre-existing terms and conditions, and whenever these conditions are fulfilled, the money gets automatically transferred without anyone’s intervention. For example, if you have booked a flight ticket and the flight got cancelled using smart contracts, you will automatically get the refund after 4 hours or according to the terms and conditions of the contract.
Rewards of using DeFi
The benefits of using DeFi is not limited to one. Apart from easy, flexible, efficient and secured transaction facilities, DeFi can offer more than the traditional financial system. DeFi can be used by anyone regardless of class, society, culture, background or anything else for that matter. In the centralized financial system, rich people are given more opportunities and financial freedom. But DeFi eliminates the distinction between the rich and the poor. The loan pool of DeFi can be joined by anyone, and they can easily give loans to others. The risks are greater here than the conventional certificate of deposit or bond fund, but with greater risk come greater rewards.
Another advantage of DeFi is that it runs on open-source code, and due to this exact reason, it can be combined and modified in countless ways. The enormous growth in the social media and eCommerce field could become the norm as a result of using DeFi.
All of this explains the enormous amount of growth DeFi has seen in recent years. As of August 3, 2021, the total market value of DeFi was $69 billion. And it has still more room for growth.
Risks of using DeFi
Although DeFi is going through a magnificent growth period, it also has some serious issues that need to be addressed. First of all, there is no regulator who can check and confirm errors during fund transfers. Also, investors won’t get any refund if any hacker exploits the vulnerability in the code of smart contracts. Almost $300 million have been stolen in the past two years, and there has been no one that can be blamed. Some DeFi systems are also violating the regulatory obligations, such as not omitting the transactions conducted by the terrorist organizations, allowing normal citizens to invest in restricted assets such as derivatives.
From where we stand today, software like DeFi can potentially change the overall economic systems, disregarding the traditional banks and other intermediaries. However, both the regulators and developers need to monitor DeFi to find out the actual potential of this decentralized system.