Identifying Key Non-Financial Risks in Decentralised Finance on Ethereum Blockchain
This article identifies twelve defined non-financial risks for Decentralised Finance (DeFi) on Ethereum blockchain.
What is DeFi?
Decentralised Finance Applications (herein called “DeFi”) has taken the world by storm since its inception in 2017.
DeFi is the transformation of traditional financial products into products that operate without an intermediary via smart contracts on a blockchain.
The value of DeFi specific to the Ethereum blockchain, has grown from $4 on August 2017, to $7,820,000,000 as of time of writing September 7, 2020. Types of DeFi applications are wide-ranging. Some popular DeFi applications include lending, stablecoins, decentralised exchanges (DEXs), derivatives, synthetic assets, insurance and asset management.
DeFi is lucrative compared to its counterpart of traditional finance as it offers yields (returns) unobtainable in traditional finance. In the past year especially, DeFi has enjoyed a meteoric rise, grabbing headlines as it has seen yields obtained by investors in excess of >1000% annualised per year, just by depositing tokens into protocols. This is in comparison to barely above 0% that one can earn by simply depositing cash into a bank.
Lending protocols in particular, are an attractive alternative to traditional finance. Many countries around the world are entering into negative interest rate environments, accelerated by COVID-19. DeFi, on the other hand, can offer users in excess of 20% on stablecoin deposits (a.k.a. assets that exist on blockchain and pegged 1:1 with various real-world fiat currences i.e. USD).
In traditional financial theory, investors can expect higher returns on financial instruments that are considered to be risky.
Traditionally, cryptocurrencies (more specifically tokens), which live on a blockchain, have been considered to be an extremely risky asset. Tokens were once used as a…