The volatility of crypto markets has led many investors to largely ignore (or, in some cases, openly mock) the vehicle. But as the digital currency edges closer to the mainstream world and more digital assets utilize some of the same tools as crypto, maybe you’ve decided it’s time to learn a bit more.
There’s a lot of mystery and even more buzzwords. Covering all of those, though, is the concept of decentralized finance, or DeFi. Here’s a look at what that term means and the risks and rewards it carries.
What is DeFi?
Decentralized finance is a catch-all term for any platform that uses the blockchain and peer-to-peer financial networks as an intermediary to send or receive transactions. It’s a high-tech alternative to human middlemen that proponents say is fair and trustworthy. (There are, however, many who disagree with that assessment.)
What makes it so important?
DeFi is how trades are made. But it’s also a lending platform, an options market and more—all in a decentralized format without the red tape and regulations the TradFi (traditional finance) markets are required to follow.
Basically, it takes the premise of digital currency and expands it into a digital alternative to Wall Street, minus the traders and other expenses.
I’ve heard transactions are anonymous. Is that true?
Nope. While there is some layer of anonymity (i.e. transactions don’t include a person’s name), all buys and sells are traceable, as they’re recorded on the ledger, which can be accessed by anyone. Authorities or bad actors with advanced tech skills can typically link trades to individuals, should they wish.
How big is the DeFi market?
That alternates with the markets, of course. As of March 10, the crypto markets were tumbling once again, with Bitcoin falling below the $20,000 mark. That lowered the DeFi market cap to $44.5 million, putting it among the top 50 banks in the world, but just barely.
Sounds simple enough. Why are people worried about DeFi, then?
It comes down to regulation—or lack thereof. There largely aren’t any of the typical protections and safeguards that protect investors in other financial vehicles. It’s also a big fraud target, with over $10 billion lost to hacks and other scams in 2021. And since the funds aren’t insured, like those covered by the FDIC, victims usually have few, if any, ways to recover their lost funds.
Senator Elizabeth Warren (D. – Mass.) in a December crypto hearing, called DeFi “the most dangerous part of the crypto world.”
“This is where the regulation is effectively absent, and — no surprise — it’s where the scammers and the cheats and the swindlers mix among part-time investors and first-time crypto traders,” she added. “In DeFi, someone can’t even tell if they’re dealing with a terrorist.”
Yikes. So what’s the appeal, then?
For traders, it’s easy to jump into. There is no application process or paperwork. You simply need to create an account and you’re off. The perception of anonymity also appeals to some people.
Flexibility is one of the chief draws for users. You can move assets at any time, day or night, without fees and without a wait. And, proponents argue, it’s superior to the current banking system, whose code is not as up to date. Those same evangelists often believe that decentralizing financial systems could be a remedy to the power big banks hold.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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