Though the DeFi space is nascent now, it can play a game-changing role in the way conventional financial systems function. It offers individuals irrespective of their income level or geographical location access to basic financial services and applications without the interference of any intermediaries in the system. Hence, the unbanked sections of the population are the biggest beneficiaries of Decentralized Finance development. Decentralized Finance (DeFi) is being developed on platforms like Ethereum, EOS, TRON, and IOST.
Why Ethereum Is the Pioneer of Defi Development
- Different applications can be combined together favouring network effects and interoperability.
- It ensures an advanced level of decentralization, programmatic flexibility, and presence of a truly enthusiastic developer base ensures that applications developed on the Ethereum platform will get the most usage in the long run.
- Ethereum is highly scalable and has consistent usage leading to an increase in the adoption of Decentralized Finance (DeFi).
- A whopping 203 projects have been built on Ethereum according to defiprime.com compared to EOS which has 22 projects and Bitcoin which has 26 projects on its platform.
- The different projects built on Ethereum include asset management tools, crypto wallets, management dashboards, options trading, insurance, and decentralized exchanges.
- Ethereum is the numero uno choice for DeFi projects with the highest number of applications being developed, application activity, user activity, and volume of funds traded.
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What Is the Aim of Decentralized Finance Development?
- It aims to create a permissionless financial ecosystem accessible to everyone in the world based on blockchain infrastructure which operates using public distributed ledgers.
- It covers every activity of the mainstream financial system like trading, investment, borrowing, lending, wealth management, insurance, asset management, and payments.
- It is based on DApps or protocols and ensures a peer to peer financial network.
The Advantages Offered Through Decentralized Finance (DeFi)
- It is highly resistant to transaction censorship and ensured active worldwide participation irrespective of social status and dispenses the need for any third parties.
- Their transaction speed is ultra-fast and also performed at a low cost. The financial contacts are immutable.
- The user has full control over his funds and data through the use of his private keys.
- A high level of transparency is ensured through price and market efficiency.
- The principal-agent risks are minimum and all the personal interests of the users are governed by a well-defined transparent protocol.
- Users can sign up even without having a bank account or a valid credit score.
- It does not depend on any agencies like governments and central banks.
- There is no human intervention due to the presence of smart contracts deployed on the blockchain network which act as self-executing programs.
- The entry barriers are low as a user just requires a cryptocurrency wallet, a compatible device, and an internet connection to get started on a DeFi platform.
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The Major Challenges to Defi Development
- All the DeFi projects being undertaken now are undergoing technical experimentation and innovation.
- It does not have sufficient liquidity when compared to centralized platforms. Only when it has adequate liquidity, it can ensure efficient pricing for different services to be availed by the various users.
- Overcollateralization of products is an issue due to the absence of credit scoring evaluation of the users. Capital efficiency is high in centralized systems due to sophisticated deleveraging systems, liquidation algorithms, and usage of insurance funds.
- Bugs in smart contracts and blockchain layers are some of the technical risks that must be taken into account seriously before it causes much harm to the business operations as fraudulent transactions are generally irreversible on the blockchain network.
- There are operational headaches due to the failure or the manipulation of the price feeds and complex governance protocols.
- Ethereum has faced some network congestion issues leading to delays in settlement of transactions causing market inefficiency and delay in transmission of information to the different participants. The highly expected Ethereum 2.0 launch in December 2020 is expected to solve these problems.
- In case, the execution of transactions are prioritized based on the gas fees used, transactions with lower gas fees may be left pending with the higher gas fees being given more priority leading to unnecessary friction on the platform.
- Stable block mining is needed as the state of the blockchain network is updated regularly. The interest rates and prices are calculated per block in DeFi projects.
- Lenders may sometimes demand significantly higher collateral to be put for their loans.
The Future in Store for Decentralized Finance Development
The problems faced with smart contracts can be solved by extensive audits, organizing bug bounties, and having a collaborative and supportive approach while building new solutions for the world. If every single tool, smart contract, DApp can interact with each other and enable digital assets to easily flow between each blockchain network, it will increase DeFi’s liquidity, utility, and usability by many times.
It also has to take progressive measures to overcome the issues of low liquidity, unintuitive user experience, capital inefficiency, and uncertainty in regulation across the world. Many flash loan and arbitrage attacks have resulted in losses of funds for users without any chances of recovery. Token prices have also been getting pumped and dumped after a few hours leading to outright scams affecting the credibility of the growing DeFi industry.
The projects being developed currently are building applications for the next generation of financial networks to transform the world of money. The current financial system suffers from problems like unequal access, social discrimination, transaction censorship, lack of wealth protection due to inflation and economic downturn, counterparty risk, and a complete absence of transparency.
Jurisdictional issues also affect the large-scale implementation of DeFi as financial sectors are highly regulated in many countries, and DeFi does not have any central party taking any amount of responsibility for providing services. Since there is a lack of a documented legal relationship between the user of a DeFi platform and the counterparty, it can lead to a severe challenge in case the user seeks protection from his creditors by filing a petition for relief under the law. Despite some bottlenecks, Decentralized Finance (DeFi) can change certain aspects like decision making, risk-taking, and record-keeping of the traditional financial system.