DeFi platforms are structured to become independent of their developers and backers over time and ultimately to be governed by a community of users whose strength comes from holding the protocol’s tokens.
In comparison, centralized finance, or CeFi, businesses are more like traditional finance, or TradFi, where consumers enter into an agreement with a company like BlockFi that collects information about them, obliges them to transfer their crypto and also serves as a focal point for regulators.
What is Ethereum?
Ethereum is the primary network developers use to build decentralized platforms for cryptocurrency lending, lending, trading and more. Ether is the cryptocurrency, or token, used to pay to operate on the network. Because the Ethereum blockchain is so popular and made it possible to create new offerings, Ether is widely used and crypto fans are raving about its value. It is the second most valuable cryptocurrency by market cap after Bitcoin, with over $460 billion as of early September.
What are the risks associated with DeFi?
DeFi eliminates the third parties that US financial regulators rely on to ensure market integrity. Licensed operators such as banks and brokers play a quasi-government role in traditional financing, collecting and reporting data to authorities, including information on capital gains on investments made by their clients, to ensure that taxes are paid. Their participation in the market depends on following many rules.
DeFi programs, on the other hand, are unregulated apps created by programmers interested in capital markets. Users’ assets can and have been hacked, and not all operations are built in good faith. “Rug pulls,” when developers leave programs after investors contribute significant assets, are notorious in DeFi.
What’s good about crypto financing?
Innovators claim that crypto promotes financial inclusion. Consumers can earn unusually high returns on their assets, unlike banks. One in ten American adults say they don’t have a checking account, and about a quarter have a low bank account and cannot qualify for loans. Crypto firms say they are meeting their needs and, outside of the United States, providing financial stability to customers in countries with volatile government-issued currencies.
Crypto financing gives people long excluded from traditional institutions the opportunity to transact quickly, cheaply and without judgment, industry proponents say. Since crypto backs their loans, the services generally do not require credit checks, although some use customer identity information for tax reporting and fraud prevention. On a DeFi protocol, users’ personal identities are generally not shared as they are judged solely on the value of their crypto.