The DeFi sphere is considered one with the most hype and profit in the crypto industry. The world of decentralized finance is very diverse. Today, there are thousands of projects with different functionality and practical significance. However, the market is overflowing with a huge number of “junk” tokens. If someone wants to make a fortune on the cryptocurrency, they come across DeFi. However, in the world of decentralized finance, there are a considerable number of problems that are getting worse every year and lead to the emergence of distrust by investors in these products. Igor Zakharov, CEO of DBX Digital Ecosystem, spoke about the current problems of the DeFi sphere and shared his opinion on whether this branch of the crypto industry is really coming to a close.
- It is believed that the DeFi industry is now going through difficult times. Some even say that it is dying. What do you think about this?
- Any new technology is bound to face some challenges in its early stages, but that doesn't mean it's a failed project. Global conditions have unleashed a series of unfortunate events not only in the DeFi space, but in other realms as well. Global inflation has forced governments and institutions to make some difficult and possibly necessary decisions to save the economies. As a result, higher interest rates have had a negative impact on cryptocurrencies and DeFi, causing some large investors to shift their focus away from DeFi towards a possibly more stable investment. This led to a further fall in the cryptocurrency market.
But should we conclude that this is the end of DeFi? Remember that people still crave what DeFi offers, i.e. fast transactions, direct financial control, and privacy. Banks and other financial institutions do not yet provide these services. People are determined to take back control of the institutions that control their finances, which is why decentralized finance, even when facing challenges, is still the answer that most people are looking for. If players in this space insist on their mistakes, DeFi will definitely be the future of finance.
- One of the major problems of the DeFi sphere is the lack of security and vulnerability of smart contracts. Every now and then, there is news about successful hacker attacks and hacks. Why, although the issue is very acute, do we observe no positive dynamics in this issue and is the situation only getting worse?
- The DeFi points of sale themselves also carry high risks. Since DeFi applications are inherently decentralized and open to everyone, this means that almost anyone can come up with their own DeFi protocol and smart contracts. Since there are practically no security standards or regulations for these smart contracts, some of them can easily be exploited by hackers. It is also important to remember that blockchain transactions are nearly impossible to trace back to sender or recipient and are irreversible, so once a hacker is successful in their exploits, it could cause millions of dollars in losses that may never be recovered. All of this makes DeFi a prime target for hackers and scammers.
So why does little action seem to be taken to prevent such attacks? The truth is that some measures are taken to protect against certain types of attacks, but they do not work. For example, there are security audits that can be performed to detect bugs in smart contracts, such as reentry attacks and general coding issues. Penetration testing is another technique that can discover potential vulnerabilities in the DeFi protocol or the entire blockchain. This will give developers the opportunity to fix any flaws before hackers discover them. But as with all computerized systems, nothing is 100% secure.
The nature of DeFi allows dirty players to carry out certain types of attacks with just a brief address to the target systems. DeFi lending and borrowing protocols give attackers easy access to capital, and they can get huge unsecured loans that they can easily repay by manipulating the system (also known as an instant loan attack). DeFi protocols are still in their infancy, as is security. Anonymity, speed and irreversibility of transactions only complicate the prevention of hacks and attacks. The best option right now is to follow the available best practices and implement security checks and audits to keep systems as secure as possible.
- Why is this area so attractive to scammers and hackers?
- At their core, decentralized finance (DeFi) and other cryptocurrencies are based on the notion that the financial system as we know it is outdated and needs to be updated. Decentralized finance is driven by the desire of people to eliminate intermediaries (banks, institutions, governments, etc.). Cryptocurrency offers speed, anonymity, and little to no rules on how you transfer or spend your money. Anonymity, speed and lack of regulation are ideal conditions for any fraud scheme. Fraudsters should be able to transfer money quickly and anonymously without question. This attracts scammers to crypto and DeFi. The lack of regulation creates another opportunity for these scammers.
The fact that much of DeFi is unregulated means that anyone can up and create a DeFi application or even an entire protocol. This has at least two implications. First, this means that fraudsters can easily create a fake product and attract investments only for them to lose their money and abandon the project. Second, new applications and protocols are easy targets for hackers who understand blockchain protocols the same if not better than the developers.
- It's no secret that the DeFi market is oversaturated. There are many useless and scam projects, which only undermine the trust of users in the field. What can you say about this? Is this problem really very acute?
- To be frank, there is always significant competition in any market. In the blockchain and crypto spheres, it is especially acute because this market is quite young and the rules by which players must play their game are not fully defined. The questionable quality of projects repels investors, yet quality standards are still not defined, so investors prefer to invest small amounts, but in numerous projects. Decentralization in the crypto sphere has become not as evident as it was at the beginning. Crypto exchanges have essentially turned into centralized platforms where users do not have anonymity and depend on government regulators, so DeFI projects will be popular regardless of increasing competition.
- DeFi is characterized by the highest volatility. It reacts sharply to any negative news in the market. DeFi platforms suffer big losses because of a sharp drop in token prices. Users lose their funds and are not always fully compensated. Why is this asset class so volatile?
- There are a number of reasons why cryptography is so unstable, and perhaps the simplest reason is that cryptography is still a relatively new concept that will take some time to settle down, gain stability and become widespread. Another reason for the volatility of cryptocurrencies is that, by their very nature, cryptocurrencies are not controlled by any one party or entity. Unlike fiat currency, for which central banks and federal reserves impose rules and policies to control the value of their respective currencies, cryptocurrencies do not have such regulators and the value of the cryptocurrency market is subject to the laws of supply and demand.
Sentiment is an enormous factor in determining the price of cryptocurrencies. Since there is practically no historical data that could be used to predict the movement of cryptocurrency markets, most of it is purely speculative and based on investor sentiment. Many people buy cryptocurrency because they believe it will rise in price and bring profit. When such investors incur losses, they sell their cryptocurrency under the influence of negative sentiment and move to another market. Both negative and positive sentiment determine whether a cryptocurrency goes up or down.
- Continuing the discussion about the negative aspects associated with the DeFI sphere, the increased regulation of decentralized finance is worth mentioning. Some countries even ban DeFi ads officially. Why does the regulator consider this particular sector of the crypto industry the most dangerous and risky?
- Governments and the regulators they control always view the emergence of new money as a potential threat to their financial system. In the case of DeFi, this is especially critical, since it is impossible to track people and their transactions. All financial flows on DeFi websites are marked only by the wallet address, so regulators consider such flows as “gray” or even “black” transactions outside the system. This means that it is impossible to apply tax obligations to participants or counteract criminal structures. It can be expected that this struggle will not end until regulators learn how to track a specific person's transactions. DeFi does not involve user identification, so we shouldn’t expect that regulators will change their mind.
- The need to have a separate token for each operation in the DeFi market forces users to make many “extra” token exchange transactions. What inconvenience does this create for users, and are there any ways to solve this problem?
- Extra exchange transactions always entail additional costs. You also have to understand the features of each token and each platform, which is not always possible for an ordinary user. The obvious solution is to create a universal platform for the exchange, where all the bridges and connections with other blockchains necessary for the exchange have already been established, and the user only needs to conduct an exchange transaction. Such a service allows you to reduce commission fees for users and eliminate the immersion of the user into the study of the technical features of blockchains.
- What changes can save the DeFi industry from decline? What should developers of old projects and those who are going to launch another startup pay attention to?
- While DeFi is an exciting innovation in finance, it is still striving to gain mainstream adoption. There are a number of reasons for this, and in order for DeFi to achieve its goal of providing more users with access to decentralized financial services, these issues will need to be addressed. One aspect that needs attention is the cost of executing transactions. Most DeFi projects run on the Ethereum blockchain. The sheer number of transactions on the same blockchain results in higher transaction fees to limit congestion. For DeFi to become more widespread, this problem of transaction costs needs to be addressed. Polygon and Arbitrum are just some solutions being developed to solve this problem.
The second is the interoperability aspect of blockchain networks. Each blockchain has its own design, protocol, controls, etc. This creates a problem for many users who would like to transact between blockchains seamlessly. And, as is the case with the rest of cryptocurrencies, DeFi faces regulatory challenges that prevent mainstream adoption. This lack of regulation also opens the door for attackers to carry out malicious activities leading to the loss of investors' funds. This makes many investors and institutions reluctant to adopt DeFi without proper regulation. Again, for DeFi to become mainstream, regulators may need to create a regulatory framework that, among other things, will protect user and investor funds.
- Is it possible to talk about the decline of DeFi and the fact that the time of decentralized finance has passed? Or does this area of the crypto industry still have practical and investment value for crypto users?
- The decline of this sphere is hardly possible because society has always wanted to have independent markets in which it itself sets the rules. This dream of being free from regulators will never die. However, it is to be expected that regulators will try to gain a foothold in the DeFi sector in order to have at least some influence on the situation. We are only witnessing the beginning of a protracted battle where the world of ordinary people, for the first time, may not obey the rules of the regulatory bodies. DeFi has a number of undeniable advantages, so its practical value is very high. In terms of investment value, here we have to look at the potential inflow of capital. When crypto-exchanges didn’t block users or introduce mandatory verifications, DeFi was not widely popular. However, now we see that due to a number of restrictions and unpredictable behavior of exchanges, users are massively leaving for WEB 3.0, prefer to store crypto assets in cold wallets and use decentralized platforms for exchange. If the trend continues, then more and more users will prefer DeFi, which means that a new amount of capital will come into the sector, which in turn will ensure the growth of the capitalization of DeFi projects.
- What are the prospects for the DeFi industry? What things that are unique, useful and in demand can the decentralized finance market offer to crypto enthusiasts in the future?
- Not to repeat what’s been said, the blockchain and the cryptosphere are still very, very small, compared to other well-known markets. The entire crypto industry is reminiscent of the Internet at the dawn of its existence. It was feared and not understood, but the need for development has done its job and now the Internet competes in terms of turnover with all known global markets. We expect the same from the crypto industry. Inevitably, there will be an influx of capital into the classical markets. This amount of working capital can only be served by truly reliable projects, including DeFi projects. The uniqueness of decentralized finance has been that the user himself decides to disclose his identity and his finances, therefore, with the influx of capitalization, there will be more and more such users. The growth of this market is inevitable! But of course, every investor wants to know the very moment to enter it. If you look globally and evaluate the entire industry as young and promising, virtually any "now" moment is suitable for investment. One must be prepared that these investments have the status of long-term ones and should not worry in the short and medium term. As for the future, DeFi always offers an alternative to conventional crypto exchanges, so it is possible that with increasing pressure from regulators, this alternative will become the dominant mode of exchange in crypto finance.