With the rapid growth of DeFi, or decentralized finance, there have been a lot of DeFi facts and myths that have caused confusion. What are some DeFi facts and what are some debunked DeFi myths?
Anonymity of DeFi
DeFi Myth: Anonymity of DeFi enables crime — Since DeFi doesn’t require KYC, all transactions are anonymous.
DeFi Fact: DeFi is not anonymous — It is pseudonymous since its transactions are recorded on public blockchains like Cardano. Blockchains are distributed ledgers that maintain a record of every transaction. While anyone with a crypto wallet and internet connection can use a DeFi dApp without KYC to obtain crypto most users use fiat, which is heavily regulated and traceable. For example, a user could sign up for the centralized exchange Kraken, complete the KYC requirements, and deposit fiat currency onto their Kraken account to buy a cryptocurrency like ADA. Once the user has bought the cryptocurrency, they can transfer the ADA to a personal crypto wallet like Eternl or Nami, which can be used to interact with dApps in the Cardano ecosystem. dApps that use public blockchains like Cardano will have all their transaction data, including wallet addresses and transaction details, publicly available to everyone through blockchain explorers. Even though the user used their personal wallet to interact with a dApp, their original fiat-to-crypto ramp via Kraken and public transaction history can be used to trace the original source of funds to Kraken, who could be compelled by government authorities to disclose any personal identities linked to certain transactions.
DeFi eliminates risk for all users
DeFi Myth: DeFi use of blockchain makes all DeFi dApps secure — Since DeFi are on public blockchains like Cardano or Ethereum, they are risk-free, and my funds are always secure.
DeFi Fact: DeFi dApps are only as secure as the developer’s code — DeFi uses the blockchain to record transactions, but the complex actions behind DEXs or lending protocols is based on code. DeFi dApps are smart contracts, which are self-executing agreements written in code on top of blockchains like Cardano and Ethereum. While the Cardano blockchain may be secure, the code for a dApp may not. For liquidity pools, users deposit their crypto into smart contracts, which governs the use of their funds according to the code. However, if there are bugs or vulnerabilities in the code, illicit actors can exploit these and steal user funds. For example, in the Ethereum DAO Hack, the Ethereum blockchain was never compromised, but the smart contract that governed the DAO, or decentralized autonomous organization, had vulnerabilities that was exploited. When evaluating DeFi dApps, analyze the developer’s team and their skillset. In addition, make sure that the smart contract’s code has been audited by reputable firms. Even when a firm takes these steps, it’s still possible an exploit could happen. DeFi dApps are only as secure as its code.
DeFi will replace banks
DeFi Myth: DeFi will replace all financial institutions, such as central banks — DeFi offers similar services as traditional financial institutions such as DEXs, lending/borrowing, insurance, and stablecoins. With DeFi, financial institutions such as central banks will all be eliminated.
DeFi Fact: DeFi will be complementary to traditional finance for many years to come — DeFi, while growing, still lacks on some fronts such as safety of user funds and scalability to become easily usable by billions of people. Potential regulation could hamper crypto adoption and some countries have banned its use. However, there are some countries who have adopted Bitcoin as legal tender. The next step could be adopting government sanctioned DeFi applications.
While DeFi has potential, there are some debunked DeFi myths such as being anonymous or riskless. In addition, scalability and security remain key issues that DeFi will have to solve for mass adoption. What are some DeFi facts? DeFi has brought financial tools to unserved populations and innovations such as stablecoins that are quickly revolutionizing the global financial system.