The rise and fall of DeFi and its evolutionary direction
The rise and fall of DeFi and its evolutionary direction
After Bitcoin gained institutional attention, many financial experts predicted that the world would change significantly due to the adoption of cryptocurrencies.
However, as of now, it is clear that Bitcoin has rather limited applications, such as only acting as a value-free store and transfer. More application scenarios are clearly needed to drive transformative decentralized financial tools and make the vision of cryptocurrency a reality, and Defi has gained momentum in recent years, driving the rapid rise of the ethereum network while giving the community an initial exploration into the world of decentralized finance.
The honeymoon phase of DeFi hype has recently come to an end with the cyclical change in market conditions. Against the backdrop of a bear market, there is a greater need to calmly analyze the ills regarding the DeFi industry and how to properly assess DeFi's place in the future financial world.
DeFi is an acronym for Decentralized Finance, a new financial tool based on a distributed ledger. Its ultimate goal is to decentralize financial services while providing users with the ability to conduct transactions without intermediaries, which also includes end-user savings, as the removal of intermediaries means that no centralized institution is needed to execute transactions and users control and transfer their own assets themselves, making the technology more attractive and further contributing to DeFi's popularity.
Centralized finance vs. decentralized finance
First, it is worth noting that most cryptocurrencies are traded on centralized trading platforms. Centralized finance (CeFi) stands for centralized finances, for example, in centralized trading platforms where users do not hold the private keys to their crypto wallets, but rely on the reputation of the platform to host and trade cryptocurrencies. Since these institutions need to comply with legal rules and regulations, CeFi also needs to meet KYC procedures to receive their full services.
On the other hand, decentralized finance (DeFi) is unregulated and without intermediaries. All transactions are based on smart contracts, allowing transactions to run automatically without third-party intervention. Since no user authentication is required, DeFi financial services can be accessed by everyone, including unbanked users living in third world countries or regions.
The only barriers to DeFi are Internet connectivity and a basic understanding of the principles of cryptography. while CeFi operates in the same way as banks and centralized institutions, DeFi aims to provide transparency, an open source platform and a system that does not require special licensing for its services, including trading, lending, pledging, asset storage and more.
DeFi's expectations and reality
When DeFi was first created, the market was full of skepticism and misconceptions about how its technology worked. Many users and pledgers thought that the annualized rate of interest (APY) for DeFi mining was like a windfall of money, and all users had to do was pledge crypto assets over time to keep the returns high.
However, this was not the case, as many investors did not have sufficient understanding and due diligence on the economic structure of DeFi, resulting in many users suffering severe losses when participating in DeFi liquidity mining. The Defi 2.0 speculation, for example, saw some projects with pledged APYs as high as 8000%, far greater than the XX % of the DeFi 1.0 world, but such high returns were clearly unsustainable and ended in a "collapse", with users' assets tending to go to zero.
DeFi's service types
In fact, DeFi belongs to the category of services, a decentralized financial tool that can be used for various purposes, such as pledging, earnings, DAO creation, etc.
Pledged income: Pledging is a tool that allows cryptocurrency holders to use cryptocurrency to generate passive income. Investors can deposit cryptocurrencies in validators to help validate new blocks and add them to the blockchain, making the power more decentralized and thus making the blockchain more secure.Long-term investors in PoS consensus algorithm projects can earn through pledges, which work simply - transfer cryptocurrencies based on the PoS consensus algorithm to a wallet, add them to a pledge pool, or lock them in a validator. The only problem is that some cottage project scams have taken advantage of this mechanism by offering high returns and making false promises, resulting in many people losing large sums of money after locking up their assets as the market value of the project plummets.
Nonetheless, Pos pledges still have many advantages, provided that users are investing in legitimate projects with good plans and visions. Provided the above prerequisites are met, PoS is an excellent way for long-termists to earn income and also contributes to the further decentralization of the blockchain, strengthening its security. Unlike PoW mining, PoS pledging requires simple equipment (no need to compete for arithmetic power) and does not even require any other equipment to participate, making it a more environmentally friendly approach.
Liquidity Mining.The tool is a way for advanced crypto users to invest in the Defi project. Liquidity mining is a reward that users receive for providing liquidity to relevant trading pairs on a decentralized platform. It is a means of earning interest, and similar to depositing money in a bank, liquidity mining entails locking up a user's cryptocurrency for a period of time in exchange for interest or other rewards.
Profit from liquidity mining is usually expressed as an annualized interest rate and this figure is dynamic, which means it can become higher or lower.Compared to PoS pledges, liquidity mining is much riskier because it can suffer the risk of impermanent losses. This issue concerns the liquidity situation. If liquidity is static, then the model is unsustainable and it represents only a temporary boost in TVL. If a service wants to survive in the long run, liquidity must remain dynamic and actively used by users.
DAO (Decentralized Autonomous Organization).It is a way for the community to contribute to the Defi project and to introduce a truly democratized environment from a theoretical point of view.DAOs are organizations whose rules are coded in a transparent computer program, controlled by the members of the organization without the influence of a central body. The rules are set in the code of the DAO, making this structure completely autonomous without any intermediary and without intervention or interruption. On paper, this is a great idea, but it still encounters some obvious flaws in practice.
The actions of some DAO participants may conflict with the direct interests of others who can initiate proposals in their own interest when they have a large enough share of the token. This may also be the reason why the democratization of DeFi is difficult to achieve. For example, a giant whale user could create a large number of wallets, sabotaging the project or profiting at the expense of other users. This is especially evident when one compares the traditional democratic process to a DAO. Typically, 1 person = 1 vote. However, in a DAO, there is 1 token = 1 vote, so a large user who hoards a large number of tokens can completely manipulate the voting process.
Currently, the latest solution related to DAO is the assignment of professional committees, similar to the model used in Yearn Finance. These committees employ professionals to work on protocol improvements, and users can vote to elect or remove members of these committees. They can prepare updates to the protocol and then submit them to the DAO, a system that ensures that users theoretically reject unfavorable changes to the protocol and vote for more rational decisions.
How can Defi be improved?
The first is to improve the usability of DeFi. Traditional banks owe their efficiency to their usability, with applications that are easy to navigate and use, and rarely need to follow guidelines to complete a transaction or payment. The Defi protocol, on the other hand, is often complex or difficult to understand and requires an understanding of basic cryptographic principles to use securely. If DeFi's goal is to improve the financial industry, then the technology must be able to appeal to the mainstream, which it will not be able to do if it only builds DApps for niche markets without integrating into the masses.
Another issue is the need for better education.There is a global need for a larger population to be educated about crypto and decentralized technologies. Internet users have a great deal of misconceptions and misinformation about the cryptocurrency industry. For example, DeFi liquidity mining is seen as a simple passive income opportunity, when in reality, users are putting money into increasing the total value of the project lock-in (TVL), a complex strategy to incentivize liquidity to meet exchange demand. Educating potential users must increase trust, as the decentralized industry lacks a bailout available from a central institution, so if the DeFi system crashes, it must rely on itself to recover and would lead to an industry-wide panic sell-off.
In fact, some companies have already implemented these ideas in their programs to make DeFi products easier to use and more intuitive, catering to mainstream needs. In order for the industry as a whole to grow, more projects and industry players need to be involved in user experience improvement initiatives. There is a lot of innovation in the decentralized finance space, and despite the high risk of participating in the early stages of a messy investment, DeFi's value system is still worthy of continued exploration.
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