An analysis of the growing trend of Defi or open finance Development
Decentralized cryptocurrency exchanges are the newest addition to the current financial system aimed at improving access and creating equality without the presence of intermediaries in the process. It relies on a combination of blockchain technology and smart contracts. We already have many decentralized finance projects existing around us in the form of Ethereum, MakerDao, Compound, and Uniswap.
Decentralized finance is quickly being adopted in different financial aspects such as borrowing and lending, asset management, regulatory compliance, data analytics, processing of payments, transfer of money, margin trading, insurance, stablecoin development, tokenization, and dealing in derivative instruments.
It allows the exchange of assets in a permissionless environment without losing its custody. Defi or open finance development is highly resistant to transaction censorship and is quite cost-effective.
The risks related to Decentralized Cryptocurrency Exchanges
- Since they primarily depend on smart contracts for smooth execution of operations, the programs can suffer from overflows and underflow attacks.
- There is no clarity regarding the shutdown procedure of a decentralized finance project if something goes wrong. There should be some on-chain governance mechanism to decide after consulting the interests of all stakeholders involved in the system.
- The decrease in prices of assets, rise in network fees, and congestion are other problems that would eventually lead to liquidation.
Advantages rendered by Defi or open finance development
- Promotes immutability – It ensures that records are made tamper-proof and secure by facilitating regular auditability.
- Facilitates interoperability – Multiple platforms are made to seamlessly integrate and complement each other. It helps in establishing customizable interfaces and support for third-party applications.
- Ensures transparency – With a public distributed ledger in place, every transaction can be verified by other users on the network before execution. This ensures that all users are aware of the extent of activity occurring on the platform enabling rich data analysis. Anyone can view and audit the open-source code. Changes can be made to the code based on consensus from a majority of the users.
- Permissionless system – We overcome geographical and economic barriers by enabling anyone with an active crypto wallet and a strong internet connection to access Defi applications without any restrictions.
- Enables self-custody – Users are in total control of their funds and assets. They can check the usage of their personal data and impose limits on its sharing with third-parties.
- Provides incentivization – Once the validation of the blockchain has been accepted by the users, they can be rewarded with valuable crypto tokens.
An outlook of the popular Decentralized finance applications
- MakerDao – It is an open-source decentralized lending protocol and permits anyone to obtain a loan without the interference of third parties by making use of the collateralized debt position. They have pegged the value of their stable coin DAI by pegging its value to the US Dollar.
- Compound – It is a lending marketplace where users can get in-depth access to the best borrowing and lending solutions available in the market. The money markets are operated via smart contracts.
- Uniswap – It is a decentralized exchange system where users can convert ERC20 tokens based on Ethereum in a secure and non-custodial way through liquidity pools.
- Dharma – It helps in trading assets easily through semi-centralized lending and borrowing. Both Ethereum and USDC stable coins are supported for collateralization. Borrowing and lending of coins can be done by users by paying the required interest rate.
- InstaDApp – Users can optimize the performance of their assets by getting the best returns. A user-friendly dashboard allows traders to manage their investments seamlessly. Currently, a mind-boggling amount of $80.7 million is locked up in InstaDApp smart contracts.
- Synthetix – It acts as a derivatives liquidity protocol powered by Ethereum and provides synthetic versions of real-world assets such as Bitcoin, dollars, gold, etc.
Obstacles to the growth of Decentralized Finance
- Hacking of smart contracts – With the code of the self-executing programs becoming public, hackers can exploit vulnerabilities present in it and create havoc. It can lead to loss of funds for the users. It would be very tough to reverse such disasters. Hence, investors can lose large sums of money if developers make a single mistake.
- Non-scalability of Ethereum – With Ethereum becoming the hub for developing decentralized finance applications, issues in its scalability is a huge cause for concern. It can eventually lead to an increase in costs for developing dApps and cause network congestion. An upgrade in the network would be the best solution to sort out this pressing issue.
- The problem of over-collateralization – With markets being highly volatile, lenders are demanding higher security on their loans due to lack of guarantee. Hence, additional amounts of collateral will be needed from borrowers to avail of loans. The unbanked sections of the population will suffer if borrowing activities are scaled-down. It would also lead to a fall in profits from leverage trading.
- Users’ access to their tokens – With tokens being controlled by the programmed smart contracts, it acts as a non-custodial financial service. However, the users must be granted access to the private keys for handling their own funds.
- Low liquidity – With so many diverse types of currencies and tokens exchanged in a single system, the traders may find it difficult to move their assets around seamlessly. This affects the trading value of assets.
The future of Decentralized cryptocurrency exchanges
While centralized cryptocurrency exchange continues to dominate the growing industry by handling the bulk of the trading volume and the number of users, decentralized cryptocurrency exchanges would work wonders if the bugs in the code are altered and they are made more interoperable.
Governments all over the world need to keep the pace of this new development by formulating a clearer framework for investors to stay within predictable legal parameters. Participants should be able to transfer value across different blockchain networks and dApps with high liquidity. The technology is still in the experimental stage. However, the adoption of decentralized finance will help traders to deal with their assets more flexibly.
Since it acts as being independent of the existing fiscal and political systems, it can help in preventing any instances of censorship, prohibiting any sort of discrimination, and allow a more transparent environment by satisfying the interests of multiple stakeholders. Its biggest strength lies in cutting out the presence of a middleman and reducing the fees charged for various services. Decentralized finance aims to create a promising future for the world by promoting equality.