The main idea standing behind DeFi is pretty simple. People bring the liquidity that the smart contract architecture uses in a specific way. For example, it lends out at interest or runs liquidity pools to charge fees. Both the DeFi team and the liquidity provider benefit from the situation.
At the same time, people seem to have a lot of pent-up aggression toward centralized services because of never-ending hacks, exit scams, the mounting pressure of regulators. So, the liquidity has started to flow toward the decentralized segment. In any case, this process has only started, and it is not yet completed.
Most recently, the largest DeFi hack within the crypto industry took place. The Poly Network hack resulted in over 600 million dollars removed, and then returned, from Binance Chain, Ethereum, and the Polygon Network.
According to the report by crypto intelligence firm CipherTrace, DeFi hacks totaled $361 million by July 2021, accounting for three-quarters of the total hack volume of the entire crypto industry for this year. This represents a 2.7 times increase from 2020.
Challenges crypto faces today
- If the blockchain that hosts a DeFi project is unstable, the project spontaneously inherits this instability from the blockchain.
- Smart contract vulnerability is a major source of issues for many DeFi projects. If there is the slightest flaw in the code of a smart contract, it can lead to loss of funds.
- There is a lack of insurance. Insurance protects investors in the event of hacks or other fraudulent activities. Insurance plays a very important role in centralized finance, while it is much rarer in DeFi.
- Creating decentralized finance is the main purpose of creating bitcoin and blockchain, but sometimes decentralized finance isn’t as decentralized as it should be. Decentralization greatly reduces the possibility of scams.
- DeFi transfers responsibility from intermediaries to users. If you lose your funds by mistake no one will be responsible. Freedom brings responsibility, and many users are not used to having to take care of themselves in this way; which can lead to them losing funds or being scammed.
A Silver Lining
The situation may seem to be disastrous, yet many experts are sure that such crimes may improve the sector of DeFi.
For instance, according to the chief financial analyst of CipherTrace John Jefferies, the recent hacks and fraud will help DeFi in the short term: “If an anonymous hacker can steal millions of dollars from unnamable victims, then it’s clear this sector needs more effective security controls.”
He also notes that DeFi crimes will spark an acceleration of Know Your Customer(KYC) legislation in respect to DEXs.
According to DappRadar, the total value locked in DeFi over the past year exceeds $108 billion. The rise of DeFi is forcing regulatory bodies to implement guidance against money laundering, fraud, and other illicit activity.
DeFi must slow down
For now, it’s clear that the vulnerabilities of DeFi will be eliminated either in the form of better regulations, or tighter security protocols, or both.
Another issue is that code bases are not well-reviewed and rushed to market. That’s why there’s very little time for DeFi projects to get tested for potential attacks. It would be enough to slow down a little a run all the tests properly.
The DeFi space has a long way to go. The problems of poor regulation, lack of security audit processes, and speed of innovation should be solved moving forward. In particular, the speed of innovation is important since the DeFi space is still maturing and the risks associated with these protocols must be accessed carefully.