Overview of the DeFi Sector
The growth of Decentralised Finance (DeFi) may be attributed to its immense potential to disrupt legacy financial institutions in a positive way through relying on public, permissionless blockchains. This transparent and immutable technology allows DeFi to facilitate the development of decentralized alternatives outside of the legacy financial system and its market structures. DeFi brings three primary benefits to the financial table: improving transparency, eliminating financial middlemen and democratising financial services.
The World Economic Forum claims that in little under two years, the value of all smart contract-stored digital assets skyrocketed from US$ 670 million in 2019 to US$ 13 billion in 2020.[1] This astronomical growth of the DeFi sector is unlikely to wane anytime in the foreseeable future.
For all the enthusiasm surrounding DeFi, some financial experts remain cautious about the zeal for decentralisation going too far. Aficionados become so enamored with the significant improvements brought about by it that they swing to the other extreme, with some DeFi evangelists believing that total decentralisation will be ultimately superior to any degree of centralisation. However, an increasing amount of the latent drawbacks of excessive decentralisation have begun to bubble to the surface of the DeFi landscape, and many of them are becoming so prickly that they can no longer be ignored or dismissed.
One of the most intractable shortcomings within the DeFi ecosystem is the high transaction fees which result from an inability to scale. While 2020 was a bumper crop year for Ethereum, with its total value locked (TVL) soaring to US$ 40 billion, its popularity came at the expense of acute network congestion. This is particularly frustrating for the community precisely because one of the widely touted benefits of DeFi lies in having much more affordable transaction fees compared to the average traditional financial service.[2] In terms of legal risks, DeFi solutions often have diffused or unclear accountability, making it difficult to exercise supervisory and regulatory control over market participants, which may result in market misconduct such as wash trading, insider dealing and market manipulation.
Furthermore, the novelty of blockchain and DeFi means that high technical barriers to entry may result in a lack of adoption, which may also be due in part to a misguided sense of illegitimacy associated with cryptocurrency. A final point to consider is the lack of interoperability with traditional financial infrastructure which plagues DeFi solutions, since the current financial system is built upon centralised financial institutions.
[1] http://www3.weforum.org/docs/WEF_DeFi_Policy_Maker_Toolkit_2021.pdf