DeFi vs. Traditional Finance: Solving Old Problems, Bringing New Troubles
This article comes fromCointelegraph, original author: Antonio Madeira
Odaily Translator |
This article comes from
, original author: Antonio Madeira
Odaily Translator |
As the boom in decentralized finance (DeFi) attracts more and more attention, the encryption industry has also raised an "ultimate question": Can decentralized finance completely take over traditional centralized financial (CeFi) services? In order to explore the answer to this question, Mr. Odaily (WeChat: o-daily) will share with you an in-depth understanding of various aspects of the DeFi and CeFi systems, such as advantages, advantages, dangers, and constraints.
If you want to say what are the hottest market segments in the cryptocurrency industry in 2020, DeFi will definitely be one of them. Although the activities and transaction volume in this field are still somewhat different from mainstream encryption transactions, with the emergence of a large number of new agreements, the situation Started to change. In fact, according to the latest report from ConsenSys, with the public release of the governance token COMP by Compound, the total value of the Ethereum token Ether (ETH) locked on the DeFi platform and the number of active users are expected to change from a "relatively stagnant" state in the second half of this year. Gradually soared.
1. Compound’s governance token COMP rose by 233% in the first week of trading;
2. Aave's LEND token has increased by as much as 1,000% in the past three months.
There is no doubt that price has always been a weather vane in the cryptocurrency industry, and the obvious contrast between decentralized finance and centralized finance is also displayed in "price". Although the DeFi industry is developing rapidly, given the advantages and disadvantages of the centralized system itself, mass users are likely to have access to two types of financial products and services all the time. It is not meaningful to make a broad assessment, so we will take a closer look The advantages, disadvantages, challenges and issues of each "peer" in the world of centralized and decentralized finance. In addition, we will also focus on the decentralized lending space, because this is currently one of the most popular applications in the DeFi market (in terms of transaction volume and total locked value)-in a sense, Decentralized lending has also fueled hype around the larger DeFi concept.
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What is traditional finance? What is DeFi?
DeFi is a set of financial services and products based on the blockchain. These products actually imitate some services and products that people have long been accustomed to in traditional finance, but the "interesting" thing is that there has been no centralized financial service provider for a long time Try to provide a similar service. Now, some users are beginning to act as "financial opponents" and provide decentralized financial services, thus completely getting rid of the traditional financial role of "middleman".
Currently, DeFi financial products mainly include:
1. Popular credit lending services;
2. Decentralized exchanges;
3. Stable currency, insurance, payment and custody services.
"Because DeFi runs on an open, permission-free blockchain, the interoperability of decentralized applications and tokens brings great advantages to the development of DeFi. For example, a decentralized application launched a A new flash loan feature that other decentralized applications can integrate into their own products without permission. In fact, this kind of interoperability is fundamental to the current explosive growth of Yield Farming (Yield Farming) reason."
Yield Farming opens up a new space for price arbitrage, which can be applied to other protocol tokens in the liquidity pool. The reason why Yield Farming has become the "darling" in the DeFi field in a short period of time is mainly due to liquidity mining. Without a doubt, liquidity mining is one of the most popular topics of discussion in the decentralized finance space right now. Essentially, liquidity mining means that users provide various encrypted asset liquidity to different DeFi protocols, and these users can get rewards for providing such liquidity. The idea of Yield Farming is to create a positive usage loop to attract users by stimulating the use of DeFi platforms to increase token value.
You will find that DeFi protocols such as MakerDAO, Aave, and Compound all provide lending services similar to traditional banks, but there are some differences in details-maybe good or bad. On the surface, the credit and loan services provided by DeFi are very similar to the traditional centralized financial industry, but the internal working principle of each DeFi project is very different from the internal working principle of traditional financial services.
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Can DeFi work without a centralized authority?
There are many types of lending platforms in the DeFi field, most of which are built on the Ethereum blockchain. These DeFi projects basically adopt different strategies, allowing users to borrow and lend each other without involving centralized authorization. funds. In this case, it means that the user does not need to pass KYC ("know your customer") compliance verification, nor provide any paper profile documents, etc. While this model greatly reduces red tape bureaucracy and regulatory control of centralized institutions, there may be some issues in terms of security (especially how to effectively ensure the safety of lender funds).
Stani Kulechov, CEO of DeFi protocol Aave, explained:
"One of the biggest advantages of DeFi is permissionless participation (no KYC, credit scoring, etc.), the same rules apply to everyone, and liquidity is 'borderless' (you can enter DeFi anywhere, anytime, as long as you have the internet) markets), combined with the non-custodial nature of cryptocurrencies, means you have complete control over your funds and can spend them however you want."
Next, let Mr. Odaily (WeChat: o-daily) look at three typical DeFi cases with you:
1. Taking Avae as an example, based on the liquidity pool strategy, lenders who provide funds on Avae can deposit Ether or ERC-20 tokens into a "liquidity pool contract", which brings liquidity and earns Earn interest, and even use deposited funds as collateral to lend out other crypto assets. As a result, users can obtain short-term credit lines in stablecoins or other tokens without providing any stable assets.
2. The second example is MakerDAO. This DeFi protocol allows users to lock their own ETH tokens to obtain the stable currency Dai. Usually, the ETH that users mortgage will be more than the stable currency they can withdraw, and the exchange rate will also change. . What MakerDAO has to do is to maintain Dai pegged to the U.S. dollar. Since the value of the ETH collateral they get is higher than the value of the loaned assets, it is not difficult to achieve an exchange rate peg to the U.S. dollar. ETH price fluctuates violently.
However, the original core function of the governance token was to allow users to vote on the future of the decentralized agreement, but now it seems that there is a new function: attracting assets to the DeFi platform. On a simple level, a Yield Farmer may frequently move assets on a DeFi platform like Compound, constantly chasing the liquidity pool that provides the best annual yield—of course, but as they are transferred over and over again , Assets may also be transferred to higher risk liquidity pools.
The incentive interest rates provided by different DeFi protocols are also different, and some interest rates can even reach double digits. You must know that the interest rate you can usually get by depositing money in a US bank today will not exceed 1%. In addition, the traditional financial industry requires customers to fill out a large number of application forms, information documents, and credit scores, but they also need different types of collateral, such as assets such as houses. Now, as the token industry continues to grow, these issues may soon change, as tokens representing houses, or parts of houses, can be “plugged” into DeFi protocols—albeit at a theoretical stage for now.
But the question is, is it possible to obtain such a high profit return so easily, is there no risk, and does it not require proper supervision? Let us continue to analyze-
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KYC, Anti-Money Laundering, Privacy and Accessibility
Since DeFi users can interact with financial services without the need for KYC and identification documents, the industry opens up endless possibilities for emerging economies. According to the research data disclosed by Global Findex, as of 2017, there are still 1.7 billion adults in the world without bank accounts. Many people think that the DeFi industry will benefit some poor countries the most, but in fact, there are many developed countries that cannot access traditional Financial services or the unbanked.
“DeFi can be used by anyone around the world as long as they can connect to the Internet, so many people who do not have access to bank financial resources can now borrow and lend through DeFi.”
But the problem is that although DeFi's open policy has certain advantages in providing financial services to ordinary people, it also means that illegal funds can circulate through the platform without any anti-money laundering measures. With this in mind, regulation may soon become one of the biggest challenges for the development of the DeFi industry. In addition, the mortgage token strategy applied to the DeFi industry also has certain risks, because if the price of mortgage tokens fluctuates significantly, it is easy to cause serious losses to users. Of course, most staking users currently only use stablecoins, thus essentially offsetting the risk of loss from price fluctuations.
And in terms of accessibility, DeFi can clearly provide users with an easier platform that can be opened to anyone who wishes to join, although doing so now still requires a certain level of technical understanding. On the other hand, although opening a bank account does not require any equipment or prior knowledge. But even so, some people are unable to cope with complex paperwork, and some people do not qualify for loan products, leaving them unable to access financial services. In some extreme cases, people can't even physically visit a physical branch, which is required to open an account at most financial institutions.
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Security and Centralization Issues
In terms of security, how do DeFi platforms compete with traditional finance? Or can it achieve the security level of a centralized system?
In fact, there are many aspects to consider when solving this problem. Although it is relatively difficult to hack into the banking system, it is also easy to cause private financial information to be leaked because transactions can be canceled or reversed, which of course has serious consequences for those affected. A lot of damage. In the DeFi industry, since all transactions are recorded on the blockchain, all information has been made public, but the information is anonymous, so users are usually not harmed.
Theoretically, the line between DeFi security and decentralization is not sharp. Protocols such as Aave and MakerDAO are "unhackable" because these protocols do not rely on a centralized server acting as a single attack vector. is dependent on distributed nodes. Taking Ethereum as an example, if there is no "51% attack" on Ethereum, almost no one can independently locate all distributed nodes.
1. The most typical DeFi project is "The Dao". On June 17, 2016, a hacker discovered a loophole in the coding, allowing him to withdraw funds from The Dao, only a few hours before the attack 3.6 million ETH was transferred out, which was worth 70 million U.S. dollars at the time. This event eventually led to the fork of Ethereum;
2. Recently, Balancer was also hacked. Its liquidity pool was attacked by flash loan and lost more than 500,000 US dollars. The losses were two token liquidity pools of STA and STONK. Hackers will borrow ETH from dYdX through flash loan and Convert to WETH, and then continuously trade WETH and STA. In each transaction, STA needs to pay a transfer fee, and the liquidity pool will get the balance without charging fees. Finally, because the balance of STA is close to zero, its price relative to other tokens is very high. At this time, the attacker can use STA to exchange other assets in the liquidity pool at a very low price;
3. The dForce protocol was also stolen for 25 million US dollars (although the hacker has returned most of the funds since then), this attack mainly uses the ERC-777 standard vulnerability of imBTC assets to carry out a re-entry attack. The callback mechanism allows hackers to repeatedly lend out counterfeit imBTC as collateral to cause abnormal transfer behavior.
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Scalability, Availability and Liquidity
Although many DeFi projects are still providing services, there are still some limitations in terms of usability. For example, most DeFi platforms are not translated into multiple languages, which can increase the difficulty of accessing the platform, while some visitors simply do not have a certain level of knowledge of blockchain and encryption technology. Additionally, these DeFi protocols also require Ethereum wallets and tokens, which typically require some form of finance to acquire. So, at least for now, DeFi is not as accessible in practice as it is in theory.
Aave CEO Stani Kulechov went on to explain:
"For DeFi, the biggest challenge is education - it may be difficult to get many people into the DeFi industry in a short period of time, but new educational resources are emerging all the time, which is great, because more and more people will pass the education Come and understand the industry. But if we’re going forward, education on how to use different decentralized applications is important, but education on security and risk also needs attention.”
In terms of liquidity, there is no doubt that traditional finance is still the real "king", and DeFi is just a novel concept, so it is not well known by many people outside the encryption field. This means that the liquidity of these DeFi projects is still not comparable to the scale of traditional finance. The lack of liquidity will make it more difficult for users to obtain loans or interest on specific assets. Fortunately, many DeFi projects have begun to improve in terms of liquidity, such as :
Likewise, Ethereum’s current congestion and scalability issues could hinder DeFi adoption if not resolved quickly. If the network is congested, gas fees can be high, which can cause transactions to take a long time to be processed. Even though there are blockchain layer 2 solutions available now, Ethereum 2.0 still has a long wait to be fully developed and implemented. In addition, the lack of scalability of the blockchain will also cause many other problems in the future, and the danger to both DeFi projects and users is almost imminent. Dmitry Baimuratov, head of technical content at OMG Network, an Ethereum layer 2 scalability project, explained
Summarize
"In the past year, DeFi has become a major participant in the encryption ecosystem. The transaction volume and interest in this market segment have increased significantly, especially attracting many transactions from traditional financial institutions and funds. Therefore , as Ethereum 2.0 is still under development, scaling solutions are even more important to provide the desired user experience for DeFi clients.
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Summarize
