Decentralized Finance: New Opportunities and Risks

As Maker DAO aims to evolve into a multi-collateral mechanism, the risks and rewards of decentralized finance come to the front.

Decentralized finance is growing throughout 2019, with more mentions on conferences and social media. DeFi apps take over the Ethereum network, and were the chief source of growth for the third quarter. Like other phenomena in cryptocurrency, DeFi is seen as another chance at democratizing access to finance and gains otherwise reserved for large-scale investors.

Just like ICOs mimicked stock sales, DeFi offers the opportunity for passive returns. However, crypto-based lending is still unregulated, and raises the question on whether it would be the next aspect of cryptocurrency to be regulated. Maker DAO may again be the first, as it has plans to introduce a KYC procedure if it starts accepting fiat as collateral.

So far, DeFi organizations function under the principle of a Decentralized Autonomous Organization, or DAO. But it is possible the activity of lending and interest generation may come under scrutiny.

Kadan Stadelmann, CTO of Komodo, a multi-chain architecture platform, commented:

“I think that the DeFi landscape won't become fully stable until there is more regulatory clarity around digital assets, in general, and stablecoin and collateralized loan solutions like MakerDAO, in particular. The industry exists in a legal gray area, so many enterprise businesses and institutional players hesitate to get fully involved with decentralized finance.”

The other risk for decentralized finance is the inherent volatility of Ethereum (ETH), the usual coin for collaterals, as well as the need to use the DAI stablecoin.

“The Maker Foundation could be a single point of failure for DAI and its not clear how well the stablecoin would function without the foundation. It could be pressured by regulatory authorities if the synthetic dollar becomes popular enough,” said Charles Phan, Founding Engineer of the Interdax exchange.

The technical risk is also present, potentially affecting the smart contracts used within the sector.

“Another risk for projects like MakerDAO relates to the vulnerability of smart contracts. Despite the progress made in the security of smart contracts since the DAO exploit in 2016, hackers still find opportunities to exploit vulnerabilities in smart contracts as they are deployed. Nevertheless, DAI has undergone four audits which provides some certainty around the security of the project,” said Phan.

But DeFi can still be used in regions with less strict regulations. It is giving ETH a new use case now that the coin is not participating as an ICO fundraising mechanism. For countries without access to investing, using ETH is a borderless, censorship-free way to use ETH lending and achieve returns.

More than 2 million ETH was staked in Maker DAO during the peak market of 2019. Now, the collateral is growing again, showing a tentative renewed interest in DeFi. Maker has managed to keep the stability of DAI even at the current 5.5% stability fee, while holding more than 1.6 million ETH in stake. The DAI supply has grown gradually by 20 million over the course of 2019.

DeFi is currently growing more gradually in comparison to the manic trends of altcoins or ICOs. But with caution, DeFi for now survives as a mechanism for gains as altcoins seek their paths to adoption.

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