A Brief Guide to the Challenges, Benefits, and Threats of the DeFi Industryby@strateh76
740 reads
740 reads

A Brief Guide to the Challenges, Benefits, and Threats of the DeFi Industry

tldt arrow

Too Long; Didn't Read

DeFi is considered one of the crypto industry's hottest and most profitable fields. But there are a lot of problems in the world of decentralized finance, which get worse every year. People still need what DeFi offers: fast transactions, direct control over finances, and privacy. People are determined to take back control of the institutions that control their finances, so decentralized finance is still the answer most people are looking for. Decentralized finance is based on the notion that financial system as we know it is outdated and needs to be updated.
featured image - A Brief Guide to the Challenges, Benefits, and Threats of the DeFi Industry
Shariy Ivan | Content marketer & Copywriter HackerNoon profile picture

DeFi is considered one of the crypto industry's hottest and most profitable fields. The world of decentralized finance is very diverse. Today there are thousands of projects with different functionality and practical relevance. However, at the same time, the market is overflowing with a vast number of junk tokens.

As it happens, if someone wants to make a fortune on crypto, he or she faces DeFi in one way or another. However, there are a lot of problems in the world of decentralized finance, which get worse every year and lead to investors' distrust of these products.

Is DeFi dying

Any new technology is bound to encounter some difficulties in the early stages, but that does not mean it is a failure. World conditions have triggered a series of unpleasant events not only in the DeFi space but in other areas as well.

Global inflation has forced governments and institutions to make difficult and necessary decisions to save the economy. As a result, higher interest rates have harmed cryptocurrency and DeFi, causing some large investors to shift their attention from DeFi to more stable investments. This led to a further decline in the cryptocurrency market.

But should we conclude that DeFi is over? Remember, people still need what DeFi offers: fast transactions, direct control over finances, and privacy. Banks and other financial institutions are not yet providing these services.

People are determined to take back control of the institutions that control their finances, so decentralized finance, even while facing challenges, is still the answer most people are looking for. If players in this space persist, DeFi will definitely be the future of finance.

Why DeFi still lacks security and has the vulnerability of smart contracts

The lack of security and vulnerability of smart contracts are considered one of the main problems of the DeFi industry. Every now and then, there is news about successful hacker attacks and break-ins.

DeFi projects themselves also carry high risks. Because DeFi applications are inherently decentralized and open to all, almost anyone can develop their DeFi protocol and smart contracts. Since there are virtually no standards or security rules for these smart contracts, some of them can easily be exploited by hackers.

It is also important to remember that blockchain transactions are almost impossible to trace back to the sender or recipient and are irreversible. Once a hacker succeeds in their exploits, it can result in millions of dollars in losses that may never be recovered. All of this makes DeFi a prime target for hackers and fraudsters.

So why does little action seem to be taken to prevent such attacks in DeFi? The truth is that measures are in place to protect against specific attacks, but they don't work. For example, security audits can be performed to detect smart contracting errors, such as reentrancy attacks and common coding problems.

Penetration testing is another method that can be used to detect potential vulnerabilities in the DeFi protocol or the entire blockchain. This will allow developers to fix any flaws before hackers discover them. But as with all computerized systems, nothing is 100% secure.

The nature of DeFi allows bad actors to conduct certain types of attacks with little recourse to target systems. DeFi's lending and borrowing protocols give attackers easy access to capital. They can obtain huge unsecured loans that they can quickly repay by manipulating the system (also known as a flash loan attack).

DeFi protocols are still in their infancy, as is security. The anonymity, speed, and irreversibility of transactions make it harder to prevent hacks and attacks. The best option right now is to follow the available guidelines and implement security checks and audits to protect systems as much as possible.

Why is DeFi so attractive to fraudsters and hackers

At its core, decentralized finance (DeFi) and other cryptocurrencies are based on the notion that the financial system as we know it is outdated and needs to be updated. Decentralized finance is driven by people's desire to eliminate intermediaries (banks, institutions, governments, etc.).

Cryptocurrency offers speed, anonymity, and virtually no rules about how you move or spend your money. Anonymity, speed, and lack of regulation are ideal conditions for any fraud scheme. Scammers need to be able to transfer money quickly and anonymously without question. This is what attracts scammers to crypto and DeFi. The lack of regulation creates another opportunity for these scammers.

The fact that most DeFi is unregulated means that anyone can wake up and create a DeFi application or even an entire protocol. This has at least two implications. First, scammers can easily create a fake product and attract investment only to lose that money and abandon the project. Second, new applications and protocols are easy targets for hackers who understand blockchain protocols just as well, if not better, than the developers.

Why are there a lot of useless and boring DeFi projects

It is no secret that the DeFi market is oversaturated. There are a lot of useless and boring projects which only undermine users' confidence in the DeFi field.

But we should understand that there is always a lot of competition in any market. In blockchain and crypto, this is especially acute because this market is relatively young and the rules by which players should play their game are not fully defined.

The questionable quality of projects discourages investors, yet quality standards are still not defined, so investors prefer to invest in small amounts but in many projects.

Decentralization in the crypto industry is not as unambiguous as it was initially. Crypto exchanges have become centralized platforms where users have no anonymity and depend on state regulators. So DeFi projects will be popular regardless of the growing competition.

Why are DeFi tokens so volatile

The highest volatility characterizes DeFi and reacts acutely to any negative news in the market. DeFi platforms incur heavy losses due to a sharp drop in token prices. Users lose their funds and are not always compensated in full.

There are several reasons why DeFi crypto is so volatile, and perhaps the simplest reason is that DeFi crypto is still a relatively new concept. It will take some time to settle down, gain stability, and become widespread. Another reason for the volatility of DeFi cryptocurrency is that by its nature, cryptocurrency is not controlled by any party or person.

Unlike fiat currency, in which central banks and federal reserves impose rules and policies to control the value of their fiat currencies, cryptocurrency has no such regulators. The value of the DeFi cryptocurrency market is subject to the laws of supply and demand.

The sentiment is a huge factor in determining the price of cryptocurrencies. Since no historical data can be used to predict the movement of cryptocurrency markets, much of it is purely speculative and based on investor sentiment.

Many people buy cryptocurrencies because they think they will go up in price and make a profit. At the same time, when such investors incur losses, they are influenced by negative sentiment to sell their cryptocurrency and switch to another market. Both negative and positive sentiments determine whether a DeFi cryptocurrency will go up or down.

Why do regulators consider DeFi to be the riskiest

Governments and regulators under their control always see the emergence of new money as a potential threat to their financial system. In the case of DeFi, this issue is particularly acute because it is impossible to track people and their transactions. All financial flows on DeFi apps are marked only with a wallet address, so regulators treat such flows as "gray" or even "black" transactions outside the system.

This means that it is impossible to apply tax obligations to participants and also impossible to counteract criminal structures. We can expect that this fight will not end until regulators learn how to track the transactions of a specific individual. DeFi does not involve user identification, so we should certainly not expect regulators to soften their attitude. Some countries have even officially banned DeFi advertising.

What inconveniences does a variety of DeFi tokens create for users

The need to have a separate token for each transaction in the DeFi market forces users to make a lot of "extra" transactions to exchange these tokens.

Excessive exchange transactions always entail additional costs. You also have to additionally understand the features of each token and each DeFi app, which is not always possible for an ordinary user. The obvious solution is to create a universal exchange platform, where all the necessary bridges and connections to other blockchains are already in place.

The user only has to perform the exchange transaction. Such a service reduces fees for users and eliminates the need for users to immerse themselves in learning the technicalities of blockchains.

What changes can save DeFi from failing

Although DeFi is an exciting innovation in finance, it is still struggling to gain mass adoption. There are several reasons for this. For DeFi to achieve its goal of giving more users access to decentralized financial services, these issues will need to be addressed. One aspect that needs to be addressed is the cost of performing transactions.

Most DeFi projects run on the Ethereum blockchain. The sheer number of transactions in a single blockchain leads to higher transaction fees to limit congestion. For DeFi to become more widespread, this problem of transaction costs must be solved. Polygon and Arbitrum are just some of the solutions being developed to solve this problem.

Second is the interoperability aspect of blockchain networks. Each blockchain has its design, protocol, controls, etc. This poses a problem for many users who want seamless transactions between blockchains. And, as with the rest of cryptocurrency, DeFi faces regulatory issues that prevent mass adoption.

This lack of regulation also opens the door to attackers carrying out malicious activities leading to the loss of investor funds. This makes many investors and institutions reluctant to implement DeFi without proper regulation. Again, for DeFi to become widespread, regulators may need to create a regulatory framework that protects user and investor funds.

Does DeFi still have practical and investment significance for crypto users

The sunset of DeFi is unlikely because society has always wanted independent markets in which it makes its own rules. This dream, in the form of freedom from regulators, will never die, but we should expect that regulators will try to gain a foothold in the DeFi sector to have at least some influence on the situation. We are only witnessing the beginning of a protracted battle where the world of ordinary people may not be subject to regulators' rules for the first time.

DeFi has many undeniable advantages, so its practical value is very high. In terms of investment value, then we have to look at the potential capital inflows. Until crypto-exchanges blocked users and introduced mandatory verification - DeFi was not very popular.

But now we see that due to some restrictions and unpredictable behavior of exchanges, users are leaving en masse to WEB 3.0, prefer to store crypto assets in cold wallets, and use decentralized platforms for exchange.

If the trend continues, more and more users will prefer DeFi, which means that a new amount of capital will come to the sector. This will ensure the growth of DeFi projects’ capitalization.

Conclusion: what prospects does the DeFi have

Blockchain and the crypto market are still very small compared to other known markets. The whole crypto-industry resembles the "Internet" at the dawn of its existence. It was feared and misunderstood. But the need for development has done its job, and now, the internet is competing in terms of turnover with all the known global markets.

I expect the same from the crypto industry. The inflow of a large part of capitalization from classical markets is inevitable. The important thing is that only genuinely reliable projects, including DeFi projects, will be able to service this amount of working capital.

The uniqueness of decentralized finance was and still is in the fact that the user himself decides whether to disclose his identity and his finances or not. With the influx of capitalization, such users will be more and more. The growth of this market is inevitable!

But of course, every investor wants to know where the moment is when it is already possible to enter. If you look globally and evaluate the whole industry as young and promising, then virtually any moment now is suitable for investment.

At the same time, you must be prepared for the fact that these investments have the status of long-term investments and should not worry the investor in the short and medium term.

As for the future, DeFi always offers an alternative to regular crypto exchanges, so it is possible that with increasing pressure from regulators, this alternative risks becoming the primary way of exchange in the crypto market.

I also recommend you to read: