Decentralized finance(DeFi) has created a new era of finance since its first debut in 2014. In DeFi world, cryptocurrency-backed transactions are executed automatically and smart contracts allows people to directly trade with each other without routing through any centralized systems, and as with crypto generally, DeFi is global, fast, peer-to-peer and open to all.
It is undoubtedly that DeFi is a powerful tool that can shape the digital economy. However, the current DeFi ecosystem still has a long way to go and there are some critical problems and limitations around growth & value that are worthy of discussion.
Accessibility
DeFi is in a place now where there is no apparent influx of new users. This can attribute to several factors, the major one is the difficult onboarding experience. For those who know very little about crypto or those who are typically traditional consumers of financial products, DeFi is too complicated. Most DeFi today are accessed via wallets that are browser extensions, and secured by a seed phrase. It generally takes users a learning curve on seed phrase/private key and it is fatal for them to understand the importance of it as well.
There is another major barrier in the DeFi ecosystem — how partitioned it is. If a user wants to perform a task, it usually requires navigating to several DeFi protocols. Novices normally have no interest to invest the time or effort thus more integrated solutions are needed if DeFi wants to attract the mainstream audience.
Take yield farming as an example, users earn interest on their money when they provide liquidity to DeFi platforms. This is alluring compared to the traditional legacy system because of its more attractive interest rates. If a user wants to start off with a low-fee chain, let us use Polygon as an example of what it takes to deposit on DeFi platforms, a user must:
Look for appropriate bridge protocol, and find out which assets are acceptable to bridge from Bridge said crypto asset via a bridge protocol and swap into some Matic Deposit the asset into a lending protocol
Many crypto beginners would abandon at the first or second step, some might abandon before starting because they wouldn’t even know where to begin with. If DeFi can’t make any change on this matter of usability then it will never attract a wide audience beyond a niche community.
Security
Today, DeFi projects have a total market cap of $45 billion, and the large amount of value invested in DeFi raises great awareness for security.
DeFi works by using smart contracts to fulfill orders placed by traders. If DeFi projects don’t go through complete security testing before going live, they can be very vulnerable to exploits. Simply, if there is a flaw in the smart contract, it is almost certain that some parties with malicious intentions will attempt to exploit it.
Another issue that emerges among security risks in DeFi would refer to stolen or leaked private keys. Anyone with access to an account’s private key can generate digital signatures and transactions on behalf of that account. A leaked seed phrase/private key can result in the loss of cryptocurrency and abuse of the account's permissions on DeFi contracts.
Concerns of Liquidity
Liquidity is a critical factor in DeFi-based projects. On a decentralized exchange, liquidity correlates directly with the amount of tokens locked in a liquidity pool. If a token lacks liquidity, holders may not be able to sell their tokens when they wish. If a DeFi platform lacks liquidity, it means that there is no interest in cryptocurrency people invest and there is no arena for people to trade it.
Low liquidity also leads to higher price volatility. If a token’s liquidity pool has only $10,000 in locked value, and someone sells $2,000 worth of the token into the pool, it could impact the price by nearly 20%. Automated market makers can determine how many tokens are being purchased from the pool, and adjust the price accordingly for large sales and buys.
Decentralized but only “to some extent” How decentralized is DeFi? A project is considered decentralized when it’s controlled by lots of people. For example, a project with a thousand people with a vote over its future would be less decentralized than one with ten thousand people with a say. That said, in practical terms, many DeFi projects are controlled by a few people with most of the tokens. Those DeFi projects have teams behind them, which essentially act like boards or development groups, holding meetings and making key decisions to determine their direction.
Fortunately, there is a rising number of DeFi projects started to focus on “true decentralization”. This has significant implications, a more decentralized project means it will less likely to suffer if they lose a key figure or decision maker.
Risk mitigation tool
It is perceived to be unsafe that current DeFi users do not have any guardrails in case of errors. That’s why useful risk mitigation measures need to go hand-in-hand with improved user experience. However, reversing a transaction shouldn’t be counted as one of the measures. Sure that reversibility would make it much easier to recover stolen and fraudulently obtained funds, but theoretically speaking, there is no recourse unless a legal system gets involved, which is totally against crypto’s nature of anti-supervision or third-party’s intervention.
To better help with risk mitigation, current DeFi protocols could develop safer front ends and better phishing detection tools. Safer front ends could offer users an option of enabling slower finality while more advanced users or users willing to take on more risks can access the faster, unguarded mode. A phishing detection tool can also make a huge change. Phishing detection and response functionality allow users to identify and remediate phishing threats before attacks can cause any damage.
Bottom Line
The future of DeFi is exciting. The global decentralized finance market is expected to reach $230 billion by 2030, This means more capital, more opportunities, more innovative DeFi projects and hopefully more new users to enter this space. As DeFi matures and as future projects gradually tackle the challenges above, DeFi will broaden its appeal and set the stage for future successes.