The Growth of DeFi – What Role Do Exchanges Have To Play Here?
Two Sides of DeFi Coin
The smart contract is launched by one person, and that person can change the terms of the smart contract unilaterally. This problem has been partially solved by the use of governance tokens that allow all of its holders to vote on the changes the project can make to its smart contract and other decisions it can implement. But most of the time a majority of these tokens remain in the project team’s hands.
A good thing about DeFi is that the code of the smart contract dictates the rules by which the smart contract works. And code cannot change itself, so the rules remain solid over time. Therefore, the same rules apply for everyone, and everyone is guaranteed to be able to use the service on the same terms. The rules can be changed though, but that would be publicly known since the code is publicly visible. Even though very few look closely at the code, it guarantees some level of clarity.
Another good thing about DeFi is that it is non-custodial in nature, meaning that the users’ funds are locked in a smart contract and not in someone else’s wallet, to which the users do not have the keys. However, the presence of a smart contract makes DeFi not as secure as a pure blockchain with a strong decentralisation would be because the security of a smart contract is only as strong as its code is. There have been multiple funds thefts from DeFi projects, and those have been done by hackers who were only doing what the smart contract allowed them to do. They simply exploited the vulnerabilities that the programmers of the smart contract had not fixed.
For this reason, DeFi projects resort to code auditing firms to audit their code. But even these audits do not guarantee full security of funds. Therefore, DeFi has its risks associated with the hack threat, not only the extremely high market volatility. This factor has to be reckoned with when people are about to delegate their funds onto a liquidity protocol. But in reality very few users study such things as the code and code audit because very few understand it. Therefore, they entrust their money to the projects they believe are the best ones, based on the reputation of the project’s team, their friends’ recommendations and the longevity of the project.
All in all, there are two sides of a coin: the decentralisation the way it is in DeFi is a significant step forward in finance services. On the flip side, the technological advances hold potential insecurities for investors. Since the DeFi space is yet shaping up, we will hopefully see the benefits increasingly outweigh the deficiencies.
Tackling Technological Burden
Speaking of the impact of decentralised finance on finance services in general, two big categories of projects can be picked out: decentralised exchanges and lending platforms. Decentralised exchanges allow people to use their funds to provide the services normally provided by banks – lending and market-making. These services are provided at an interest; therefore, we can say that DeFi has offered new ways of using cryptocurrency that have transformed it into a passive-income asset and have practically made mining more profitable since the coins mined no longer solely act as a store of value but can generate income on their own.
However, when it comes to doing all these operations with locking liquidity in DeFi protocols, we get faced with extreme complexity. To make it all happen, you’ll have to buy some Ether, set up a compatible wallet and connect it to Uniswap, Balancer or a different protocol. You might also need to exchange your Ether for a stablecoin to maximise your profits. So, it obviously creates a big barrier before lots of lay people who want to do liquidity mining but are not savvy enough to do it themselves.
This is where ordinary cryptocurrency exchanges come in and bridge the gap between the general public and decentralised finance. By law, the exchange has to store funds in a certain way, similar to a bank. If a customer forgets or loses their credentials to their account, they can always restore access by confirming their identity through a KYC procedure. For many people, this is an imperative for choosing centralised exchanges to store funds with. At CEX.IO, we get all the proper financial licences to conduct operations in a law-compliant manner.
The financial system is developing, and DeFi is making a significant contribution to this ongoing transformation. Exchanges are also playing their part in this development by increasing accessibility to decentralized finance for their clients. Storing their assets on an exchange is reassuring to many customers, because this way there are people who they can ask for help if something goes wrong. This helps with alleviating fears and attracting more users to the DeFi space.
Dmytro Volkov, CTO of the international cryptocurrency exchange CEX.IO