Decentralized finance is often seen as a "trustless" alternative to traditional finance, replacing intermediaries with code — but is it truly free from trust? While smart contracts automate transactions, hidden layers of reliance persist – on developers, oracles, governance structures, and even front-end providers. Security vulnerabilities, governance centralization, and regulatory pressures further challenge the notion of absolute decentralization. This article from SwapSpace CEO Andrew Wind dissects this myth, revealing why "trust-minimized" is a more accurate term.

In DeFi, "trustless" means that transactions and financial operations occur without relying on traditional intermediaries like banks or brokers. Instead, trust is placed in smart contracts – self-executing code that enforces rules without human intervention. DeFi protocols leverage blockchain consensus mechanisms, cryptographic proofs, and decentralized networks to eliminate the need for third-party oversight.

Important! "Trustless" does not mean the absence of all trust. Users still rely on developers to write secure smart contracts, validators to maintain blockchain integrity, and oracles to provide accurate off-chain data. Additionally, governance mechanisms introduce human decision-making, sometimes concentrating power on token holders or DAOs.

In contrast to TradFi, where trust is placed in institutions and regulations, DeFi shifts trust to code and decentralized systems. But this doesn’t eliminate risks like bugs, exploits, and governance flaws that reveal DeFi not being fully autonomous. Rather than being completely trustless, DeFi is better understood as "trust-minimized."

A major misconception about DeFi is that it completely removes intermediaries. While DeFi eliminates traditional banks and financial institutions, new forms of middlemen emerge—developers, liquidity providers, validators, and oracle networks — each playing a crucial role in DeFi’s functionality.

For example, decentralized exchanges (DEXs) like Uniswap and SushiSwap allow users to trade assets without centralized control, but they still rely on liquidity providers (LPs) to supply capital to automated market makers (AMMs). LPs earn fees but also take on risks like impermanent loss. Similarly, lending protocols like Aave and Compound replace banks but require liquidity pools funded by depositors.

Another critical intermediary in DeFi is oracles, which feed external data into smart contracts. Platforms like Chainlink provide price feeds, but they introduce a reliance on off-chain sources, which can be manipulated, as seen in flash loan attacks.

Interesting fact! Maximal Extractable Value (MEV) is a form of hidden centralization where blockchain validators reorder transactions for profit, effectively acting as financial middlemen.

A common belief is that smart contracts are fully trustless and immutable once deployed. While smart contracts remove human discretion in execution, they are only as secure as the code written. Thus, smart contracts aren’t fully trustless for several reasons:

• Bugs and exploits: Poorly written code can be manipulated, leading to multi-million dollar hacks.

• Upgradable contracts: Some protocols have admin keys or multi-sig wallets, allowing developers to modify contracts post-deployment.

• Oracle manipulation: Smart contracts relying on off-chain data can be tricked, as seen in flash loan attacks.

Smart contract failures have led to significant losses in DeFi. In 2016, the DAO Hack exposed a vulnerability in an Ethereum-based decentralized autonomous organization (DAO), allowing an attacker to siphon off $60 million worth of Ether (ETH). This event prompted a controversial hard fork in the Ethereum blockchain, creating Ethereum Classic. ​

In 2022, the Wormhole Bridge Hack resulted in the theft of 120,000 ETH, valued at over $320 million, due to a missing verification step in the bridge's smart contract. This incident marked one of the largest exploits in DeFi history.

Interesting fact! ​In 2022, over $3.8 billion was stolen from cryptocurrency businesses, primarily targeting DeFi protocols. This underscores the critical need for rigorous audits and continuous monitoring of smart contracts.

Decentralized Autonomous Organizations are often perceived as eliminating human trust from governance by automating decision-making through smart contracts. However, in practice, DAOs face significant challenges that reintroduce human elements into their governance structures:​

• The centralization of voting power. Studies have shown that in platforms like Compound and Uniswap, a small group of token holders wields disproportionate influence. Specifically, in Compound, the top 10 voters control approximately 57.86% of the voting power, while Uniswap holds about 44.72%. This concentration allows a few individuals or entities to steer the organization's direction.

• Low voter participation. Despite the theoretical inclusivity of DAOs, many token holders abstain from voting, leading to decisions made by an active minority. This apathy can result in governance that doesn't accurately reflect the broader community's will.

• The legal ambiguity surrounding DAOs. Without clear regulatory frameworks, DAOs and their members may face legal challenges, as seen in cases where DAOs have been treated as general partnerships, exposing members to potential liabilities.

Thus, while DAOs aim to minimize human trust dependencies, issues like power centralization, low engagement, and legal uncertainties necessitate human oversight and intervention, challenging the notion of entirely trustless governance.

DeFi is often lauded for its potential to provide complete censorship resistance, enabling users to transact without interference. However, several factors challenge this ideal:​

• Regulatory compliance by validators: Entities responsible for validating transactions, such as block proposers, may comply with regulatory directives, leading to selective transaction inclusion. For instance, following sanctions by the U.S. Office of Foreign Assets Control (OFAC) on certain Ethereum applications, approximately 46% of Ethereum blocks were produced by entities adhering to these sanctions, effectively censoring specific transactions.

• Front-end access restrictions: Users often interact with DeFi protocols through web interfaces. These front-ends can be subject to censorship, limiting access to the underlying decentralized services.​

• Centralized infrastructure dependencies: Many DeFi applications rely on centralized services for data and transaction propagation. These dependencies can become points of control or failure, undermining censorship resistance.​

The belief that DeFi operates entirely outside the need for regulation or legal oversight is a misconception. While DeFi aims to provide financial services without traditional intermediaries, several factors underscore the necessity for regulatory frameworks:​

• Investor protection: The absence of regulation can expose users to significant risks, including fraud and mismanagement. For instance, the U.S. Securities and Exchange Commission (SEC) charged individuals involved in the DeFi Money Market for unregistered sales exceeding $30 million, highlighting the potential for deceptive practices in unregulated spaces. ​

• Illicit activities: DeFi platforms can be exploited for money laundering and other illegal activities. A U.S. Department of the Treasury report noted that forbidden actors, including ransomware cybercriminals and scammers, have utilized DeFi services to transfer and launder their illicit proceeds. ​

• Regulatory enforcement: Regulatory bodies actively oversee DeFi activities to ensure compliance with existing laws. The Commodity Futures Trading Commission (CFTC) took action against operators of three DeFi protocols (Opyn, ZeroEx, and Deridex) imposing civil monetary penalties totaling $550,000 for violations of the Commodity Exchange Act. ​

These examples demonstrate that, despite its decentralized nature, DeFi operates within a broader financial ecosystem that necessitates regulation to protect participants and maintain market integrity.

While DeFi aims to remove intermediaries, complete trustlessness remains an illusion. Instead, the future of DeFi lies in trust minimization – reducing, rather than eliminating, reliance on centralized actors.

Projects like EigenLayer are exploring decentralized restaking, allowing users to extend Ethereum’s security without fully trusting third parties. Similarly, Uniswap v4’s hooks enable greater customization while keeping governance decentralized. To mitigate smart contract risks, formal verification is becoming a standard, ensuring that protocols like MakerDAO undergo rigorous audits before deployment.

Hybrid solutions are also emerging. Chainlink’s decentralized oracles ensure secure external data feeds, reducing reliance on a single provider. Meanwhile, zk-SNARKs enhance privacy and security without requiring full trust in validators.

Ultimately, DeFi is evolving beyond the myth of absolute trustlessness. By leveraging cryptographic proofs, decentralized governance, and transparent oversight, the next generation of DeFi will be trust-minimized – offering resilience without sacrificing security.

DeFi is not entirely trustless but rather trust-minimized, as smart contracts, DAOs, and oracles still require some reliance on developers and infrastructure. While risks like hacks and governance centralization persist, innovations such as zero-knowledge proofs and decentralized oracles are improving security and resilience. Instead of chasing full trustlessness, the future of DeFi lies in minimizing trust dependencies while maintaining decentralization and stability.