Revolutionizing the global financial world, the DeFi leader MakerDAO has provided the first scalable alternative to the centralized finance (CeFi) sector by offering to lend and borrowing with stable coins.
Decentralized Finance (DeFi) is no longer a distant dream, as it is accelerating at a striking rate of expansion. In 2020, decentralized finance got momentum & now it is moving towards mainstream adoption.
With its substantial expansion, DeFi has introduced innovative features to the traditional setups resulting in a massive increase in the lending borrowing, trading of token activities in this space.
Popularly recognized as DeFi summer, we have witnessed some exciting developments recently such as DeFi has achieved a $150 billion locked value, FTX has raised the largest funds ever through private rounds. With the highest locked value, MakerDAO has turned to complete decentralization & now recognized as a Decentralized Autonomous Organization (DAO).
DeFi Use Cases
DeFi has been providing more secure, transparent, and all-inclusive financial services platforms making it more lucrative than ever.
As various use cases of DeFi are being implemented in various sectors, data from Defiprime reveals 245 running projects on various blockchains with the highest number on Ethereum blockchain which has 222 running projects, EO has 17 projects & Bitcoin chain has 26. The use cases include trading, banking, and insurance, cross-border payments, betting sector, etc.
However, with more adoptions and rapid growth, a holistic approach integrating innovations and viable solutions to the current drawbacks is consistently being explored.
Currently, the DeFi product and services range caters to borrowing in leveraged lending, NFT minting, staking, yield farming activities to name a few. This product range has been built up by reforming the conventional models of treasury bills, interest-paying saving accounts, bonds, etc.
Need To Include Tangible Assets In DeFi
There is a growing need for connecting the DeFi space with centralized finance (CeFi) more than ever. This can be done with the inclusion of more real-world assets (RWA) such as real estate, collectables, etc. in the ecosystem.
Focusing on tangible assets, let’s discuss the drawbacks of the DeFi and the viability of these assets in this space.
Inadequacies In DeFi
Scope For Robust Infrastructural Setup
DeFi offers a more efficient and democratic ecosystem transforming the centralized setups but it needs to address various issues such as blockchain identity, evaluation of risks, and valuation of commodities to name a few. As it removes the intermediary such as banks which play as guarantors of the assets, more robust solutions for storage of data and custody of assets must be assessed.
Risk Of Relying On Centralized Oracles
DeFi enterprises use centralized or semi-centralized Oracles to access external data. These Oracles serve as an intermediary to the smart contracts to access the classified data from external sources. Currently, with the dearth of secure and fast decentralized oracles, 7 out of 10 DeFi applications rely on centralized oracles.
While open lending /borrowing protocols such as MakerDAO, Aave, and Compound use oracles to receive external data, there is no clarity on how Data Analysis tools such as Bloomberg and FICO manage their enormous data.
Price Volatility And Over-Collateralization
With a tremendous potential in lending markets, price volatility and over-collateralization issues should be addressed on priority.
More specifically, currently, most DeFi protocols ask borrowers to collateralize their loan at 150% of the value of their lending. If the collateral falls in value, liquidation penalty risk is obvious, similar to a centralized system.
Another significant issue is the scarcity of real cash flow behind the protocol tokens which brings price volatility and further loss in their value. Transparency in the price of collateral assets is required and thus recognized and reliable sources such as crowdsourcing enabled solutions must be initialized.
Exploring The Solutions:
DeFi Model Similar To Centralized Mechanism
Similar to the traditional financial setups, the DeFi ecosystem can include frictionless lending services, insurance security, and currencies with stable value. With a stable pricing setup, corporate borrowers can be fetched on board to link the funding demand in the centralized system with liquidity in DeFi. To bridge the real-world borrowers and the DeFi system, they can be offered a repayment option via fiat currency.
Also, a common income-generating model with an RWA-based yield strategy can be developed where centralized and decentralized investors can earn profits through crypto-assets.
An Efficient Governance Model
For a DeFi system, efficient governance for faster decision making, achieving scalability, and transparency in the process is very much needed.
Apart from Ethereum blockchain, Polkadot, Solana, Cosmos are coming up addressing the structural drawbacks of Ethereum. A multi-chain ecosystem is being considered as a viable future option for smoother functionality in DeFi space.
CeFi Assets As Collateral
To bridge the gap between the RWA and the DeFi, real-world assets such as bonds or fixed-income securities can be allowed as collateral to borrow the money from DeFi protocols.
Global Regulatory Compliance Strategy
As the DeFi doesn’t follow a global regulatory framework unlike conventional system, the involved insecurity and risk keep the traditional market players and investors away from the DeFi industry. Thus a unified regulatory strategy for compliance is very much needed to lure them.
For broader mass adoption, real-world assets must be connected to DeFi, providing infrastructural solutions to current drawbacks. While incorporating the solutions to the centralized corporate players, the interests of the DeFi community should also be the priority.