How decentralized is DeFi really?
The decentralized finance industry is a playground for yield farming, derivatives, funding, DAOs, enormously outrageous APYs, liquidity pools, and so much more, but this adult obstacle course comes at a tremendous cost if DYOR is not a preliminary step to participating.
This year to-date, DeFi experienced its most expensive exploit in history with $611 million being stolen in an intricate smart contract flash loan hack. Recently this month, the CEX Bitmart was exploited for $196 million dollars during a private key compromise orchestrated by hackers, making it the second most costly exploit of 2021. As you can imagine there is a lot to gain and lose in DeFi, but first we must explore how decentralization is measured in the industry. By gauging this variable we can answer questions such as, “Are decentralized protocols and exchanges more secure than centralized ones?”
DeFi’s “volatility” has become formidable for novices that don’t understand how to navigate this macrocosm of the cryptocurrency ecosystem. My personal rule of thumb is to at least own Bitcoin before dabbling in the DeFi market, that goes for NFTs as well. After all, both markets would not exist without Bitcoin. The argument that Bitcoin is more stable than all DeFi tokens on average holds true due to the compromises, exploits, and hacks that DeFi is faced with on both technical and organizational levels. When’s the last time you heard the Bitcoin blockchain being exploited? 2010? Exactly. And not an exploit has occurred since.
The reason DeFi exists is because Bitcoin alone does not model after the current financial system’s properties which is completely okay. That does not take away from the fact that it is the global reserve currency of the world giving billions of people access to wealth and security by-way of cryptography. Bitcoin fixed the double spending problem along with several issues that the traditional financial system presented. Bitcoin is being used as a store-of-value for those investors with long time preferences, and it is used as medium of exchange for those countries with high trading volumes that can’t survive without its deflationary utility. Its limitations lie with its scripting code base but lets not forget Bitcoin was not suppose to emulate the traditional financial system in the first place; Bitcoin is queen but DeFi is the rook.
DeFi allots for the following type of practices independent of the current financial system:
• Lending (bonds, loans)
DeFi is practically the traditional financial system conducted in a “decentralized” matter. A large conglomerate of these DeFi services tend to be centralized at inception and progress to decentralization once on the market. The best way to quantify how decentralized a project is, is by accessing how long it’s been on the market, who the are creators, and analyzing the nature of the codebase. Are the creators from the traditional finance market? Are they dox’d. Is the code, audited, functional, quality, and constantly evolving? Does the protocol have a Layer-2 solution built on top of it’s previous blockchain? What are the main value propositions to future work stated in the whitepaper? Does the whitepaper mention the journey of striving to be fully decentralized? There are many more questions to ask to drill DeFi projects before initially investing.
Risk in DeFi is an enormous headwind to mass adoption to this wild macrocosm of the cryptocurrency space. The people that are typically draw to DeFi are those who previously left the traditional financial market and are use to high-stakes trading, and also entrepreneurs who are figuring out neat new ways to create capital. The main questions you must yourself before diving into DeFi is:
What do I want to get out of this? Is it worth my sleep? Am I willing to get rugged at the expense of creating ephemeral gains.
Risk factors in DeFi is prevalent as more users pivot to DeFi to expand their economic horizons. The risks continue to exponentiate as more users are draw to its “promises” of high returns, security, and an entire forge of offerings DeFi protocols establish in their genesis. In a later publication, I will discuss risks associated within DeFi.