The Problem With Decentralized Finance (DeFi)
Decentralized finance (DeFi) has proven to be a major player in cryptocurrency, especially as of late. With projects like UniSwap, Compound, and MakerDao, decentralized finance has established itself as more than the surface-level ICO disaster of 2017––whose focus was token sales and crowdfunding rather than genuine, altruistic innovation.
DeFi has a lot going for it, there’s no denying that. Lending protocols, swapping capabilities, autonomous transactions, all through the execution of a permissionless smart contract. 2020 DeFi projects have done an especially great job at diversifying the lending and borrowing sector and have solved major obstacles within the current crypto climate, like the centralization of crypto exchanges.
Centralized market makers are also still aiding almost all of the major centralized crypto exchanges (CEXs)––Decentralized finance found a way around that through a DeFi project called UniSwap and a DeFi coin called UNI. UniSwap accomplished this through the implementation of automated market makers (AMMs) and liquidity pools instead of traditional market makers, which are third parties that are paid for in fees. For more on this topic, check out our article on market makers and liquidity providers.
Even though they haven’t succeeded in traditional finance adoption, the DeFi projects of 2020 are really making some headway, with a total of $11.23B currently locked in DeFi projects. Both decentralized exchanges (DEXs) and liquidity pools have experienced their largest increase in value yet since their conception earlier this year.
Some other services DeFi has optimized include insurance, loans, and savings.
These DeFi projects and governance tokens, like those of Compound (COMP), AAVE (AAVE), UniSwap (UNI), Curve (CRV), Balancer (BAL), Yearn Finance (YFI) all serve as an answer to ethereum’s governance problem. However, there’s talk––somewhat confirmed by the CryptoKitties fiasco back in late 2017––that Ethereum won’t be able to operate under the significant strain that DeFi will inevitably house on the network.
Even with the upcoming ethereum 2.0, which is set to implement improved scalability via Proof-of-Stake (over the more traditional Proof-of-Work)/staking coins and something called shard chains, crypto experts still wonder if it’ll be enough to hold these booming DeFi ecosystems. In fact, current projects operating on the ethereum blockchain are already a significant strain on the network. CryptoKitties gave a lot of ethereum believers a genuine wake-up call concerning dreams of mainstream adoption — a wake-up call that was probably necessary.
That’s not even counting the problems facing DeFi at this moment. Tack on rising gas fees, unprotected smart contracts (one faulty piece of code can result in a complete loss of funds), an unsecured network, a lack of asset insurance, and a not-so-great UX––it’s going to take some significant problem-solving skills to address these issues.
Unsurprisingly, plenty of projects are up to the challenge. For example, part of the problem with DeFi is — surprisingly — a lack of decentralization. This is partly because new projects, like a DEX for example, aren’t ready to handle a large user base without at least some trial and error. Without working out the bugs and “mess ups”, a lot of money could be lost or even destroyed. Progressive decentralization is a semi-new approach, where governance is given out to users over time, versus all at once where things can quickly go south without the proper guidance.
While DeFi projects like these surely want to fix the obstacles that DeFi faces, it’s also a matter of if they actually can. After all, DeFi is still in its infancy, and it has a long way to go if it’s going to ride the wave with the rest of us. But DeFi isn’t just a sector of fintech, it’s a movement. A movement based on problem-solving because, at their core, these projects are just people who want to make finance decentralized and open to everyone. We have no doubt that as new problems arise, innovation will follow.
Perhaps no project or solution to a problem will ever be completely flawless, but we believe there will always be a fintech project of some denomination out there, working towards that goal.
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