Ethereum, the crypto asset with the second highest market capitalization after Bitcoin, was developed with smart contracts in mind, a protocol that allows contracts to be concluded or executed, and is attracting attention as a crypto asset with high affinity for financial systems. . One of the features of Ethereum is DeFi (Decentralized Finance) and decentralized finance.
DeFi is a blockchain-based financial infrastructure and refers to a set of protocols built on a public smart contract platform, usually represented by Ethereum. DeFi does not require centralized management such as brokers such as securities companies or banks, but is based on distributed application DApps and open protocols. Therefore, it is characterized by high transparency and equal authority, and is expected as an alternative to the existing financial system.
At the core of DeFi, smart contracts were suggested by Nick Szabo, a researcher of cryptography technology. He compares the smart contract to a vending machine, and explains that if a coin is inserted into a vending machine, a product that fits the tentative name will come out.
Smart contracts have the advantage of easy participation and high security. This is because each participant in the blockchain where smart contracts are executed can verify transactions, which is more inefficient than existing centralized computing, but has high transparency and minimizes the risk of arbitrary intervention.
Because of this advantage, DeFi is rapidly spreading. The scale of DeFi exceeded $10 billion from the end of 2020 to 2021.
Of course, DeFi also has its drawbacks. First, there is a security key. An administrator key is used in the DeFi protocol, and a small number of predefined groups can use the key to renew contracts or prohibit emergency contracts. This is a safe participation precaution against DeFi, but there is also a risk that the key owner will be malicious or the key will be stolen by a malicious third party.
Next is the dependencies. DeFi allows various smart contracts and decentralized blockchain applications to interact, which makes it possible to create new services from existing services. This comes from openness, one of the characteristics of DeFi. However, it is also the cause of the dependency problem, which is that the writing of a program that has a problem with a specific program and a program with a different relationship is also affected. Also, since most of the smart contracts rely on external data, there are cases where dependency problems are brought into Eoansd.
Next, one of the common problems with cryptographic assets regulators is the abuse of criminal activity. In this regard, it is pointed out that the transparency, which is the advantage of DeFi, can curb criminal use, but there are two-sided concerns that may provide personal information to anonymous criminals.
In January 2021, the US Treasury Secretary said at a hearing that most of the cryptocurrencies are mainly used for illegal financing.
Next is the scalability. Blockchain is in a trade-off relationship between decentralization and security. Because Ethereum is relatively decentralized and secure, it is facing a problem that it is difficult to keep up with the demand for expansion. Centralized computing will improve efficiency, but if that happens, the advantages of DeFi and smart contracts can be compromised, so how to address the growing demand in the future can be seen as a challenge.
Based on these pros and cons, DeFi has great potential, but it also poses certain risks, but if these problems are resolved, DeFi can bring about a paradigm shift in the financial industry and contribute to building a stronger, more open and transparent infrastructure. Related information can be found here.