Review of Decentralized Finance (DeFI) as an Alternative Financial System (Part III)
The good, the bad and the ugly of decentralized finance
Since the global financial crisis of 2007/2008, where investors found themselves with investments that had lost significant value and mounting debt, confidence in traditional financial institutions has been shaken. Citizens of countries with declining economies, such as Venezuela and Zimbabwe, also hold their monetary authorities accountable for monetary policies they have implemented that they believe are not economically viable. This is one of the many reasons why cryptocurrency enthusiasts and retail investors believe that decentralized finance is the future of finance by decentering central authorities such as central banks and intermediaries such as banks and other financial institutions, and empowering ordinary people through peer-to-peer exchanges. .
Advantages of decentralized finance
Some of the benefits include:
Speed: DeFi protocols and products are processed quickly; for example, loan applications are processed on time given the speed of blockchain-based transactions. This contrasts with bank loans which can take days or even weeks to be approved.
Accessible and permissionless: DeFi products offered on blockchain technology promote access to finance, as users are not restricted by location or credit history. Retail investors can access financial products or services through DeFi, provided they comply with the terms of the Smart Contract. There is also no limit on the value that can be available to users unlike traditional financial institutions which are subject to regulatory limits. For example, the Banks and Other Financial Institutions Act 2020 provides that a commercial bank may not, without the prior written approval of the Central Bank of Nigeria (“CBN”), grant to any person any loan or facility credit so that the total value of liability to that person exceeds 20% of the bank’s equity unaffected by losses.
Transparency: Blockchain transactions are transparent because you can trace contracting parties’ wallet IDs, and transaction execution and completion times are recorded on the network. In addition, the transactions carried out there are permanent and unalterable. Once a financial transaction or smart contract has been recorded on a blockchain, its terms are visible to participants on the blockchain network and become immutable. This creates a certain form of security with DeFi financial products, as assets or transaction records cannot be altered or fraudulently manipulated. Moreover, since the terms of the Smart Contract are written as codes on the blockchain, it limits disputes over the interpretation of the terms of the contract.
As seen above, DeFi has great benefits, but there are also inherent risks.
“DeFi has great benefits but there are also inherent risks”
Disadvantages of decentralized finance
Hackers: Hackers are a major security risk for a blockchain technology network. Although it is difficult to hack blockchain technology, it is not impossible. Since 2011, more than 11,000,000,000 USD ($11 billion) worth of cryptocurrency has been stolen from hacked crypto wallets.
Strict conditions: The financial conditions of smart contracts are generally strict compared to the limited requirements. Take De-Fi loans where the required collateral is usually set to be equal in value (or more) to the requested loan. These strict financial terms limit who can realistically access DeFi products.
Counterfeits: There have been instances where scammers have used popular Dapps to list fake cryptocurrencies labeled as tokens that can be used to access DeFi protocols. Investors should be careful in choosing which digital assets they decide to invest in and retail investors may not appreciate the due diligence required.
Read also: Improving access to finance for MSMEs: issues, challenges and prospects
Investor protection: DeFi services, products and technologies are, by their very nature, generally outside regulatory oversight. Thus, the investor protection provisions to which regulated financial institutions are subject may not apply to Dapps, DeFi protocols or issuers. Without these investor protection requirements, consumers and their investments are subject to the whims of the issuers of these financial products. As pointed out earlier, there is obvious counterparty risk with De-Fi products. For example, if an issuer terminates a Dapp or blockchain technology, it could jeopardize investors’ funds or any posted collateral.
There are definite pros and cons to De-Fi that require careful consideration for anyone looking to explore De-Fi products or services. Cryptocurrency enthusiasts are always optimistic about decentralized finance as the future of finance in terms of providing financial products and services and the various innovative solutions that can result from blockchain technology.
Is decentralized finance the future of finance?
According to Benedikt Christian Eikmanns (senior consultant at the strategy consulting firm Roland Berger and doctoral student (PhD) at the Technical University of Munich), Prof. Dr. Isabell Welpe, (Full Professor (W3) at the Technical University of Munich, Head of the President for Strategy and Organization, Co-founder of the blockchain center TUM), and Prof. Dr. Philipp Sandner (Founder of the Frankfurt School Blockchain Center (FSBC));
“For the first time in history, a financial system is developing without intermediaries on a large scale. So far, DeFi applications cannot yet compete in terms of security, speed and ease of use with traditional financial solutions. But DeFi has produced real working applications that have already managed to attract billions in capital. These resources will be used to develop more competitive and user-friendly applications in the future.
This is a succinct view of the widely shared position on the future of DeFi – the future is bright! In Nigeria today, platforms like Xend Finance rely on DeFi to offer financial products to credit unions, syndicates and individuals. Credit unions provide capital and invest on the Xend Finance platform. Syndicates are given the $XEND token to hold and their capital is invested in other DeFi pools. At the end of the savings period, the returns on their investment are given to a member of the caisse for that month or period.
When it comes to the future of DeFi in Nigeria, it is important to recognize that there are currently divisive approaches from financial industry regulators regarding cryptocurrency, which may impact the usability of Dapps. and access to DeFi products. On the one hand, the CBN banned banks and other financial institutions from trading cryptocurrencies and providing payment services to cryptocurrency exchanges and further ordered financial institutions to close the accounts of customers who exploit cryptocurrency exchanges within their system. On the other hand, the Securities and Exchange Commission (“SEC”) of Nigeria in 2020 issued its “Statement on Digital Assets, Their Classification and Treatment”, which explained how the SEC would regulate crypto assets, which means the SEC Acceptance of Cryptocurrency.
While stock exchanges have found a workaround to these regulatory limits by facilitating peer-to-peer trading, this fragmented approach by Nigerian regulators may leave investors reluctant to invest funds in a financial product whose infrastructure is blockchain-based and cryptocurrency.
While DeFi is still a developing area of finance, its appeal to investors, whether institutional, wealthy or individual, cannot be underestimated, particularly in view of the various innovative solutions on offer. We also believe it will be complementary to traditional financial services, as innovation challenges the way traditional banks and financial institutions operate and deliver their services.
As more and more money is invested in the development of Dapps and De-Fi protocols, DeFi will become more efficient, easier to use, and offer various iterations of financial products that will help individuals and even businesses financially. country. The future of finance is decentralized and DeFi will only continue to grow.