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DeFi and Credit Risk

I've come across a couple of articles recently discussing the demise and decline of decentralized finance (DeFi).

The recent DeFi incidents, triggered by an exploit and a crypto founder with poor risk management skills, have served as a catalyst for change. To elaborate, the founder of a prominent automated market maker (AMM) known as Curve Finance lent out nearly half of the protocol's CRV tokens to a few DeFi lenders. Unfortunately, due to an unforeseen but somewhat foreseeable DeFi exploit, the price of CRV depreciated, putting the founder's holdings at risk of liquidation.

The initial piece featured in CoinDesk, penned by Daniel Kuhn, boldly claimed that DeFi was "dead inside." The second article, a report by JPMorgan, suggested that the entire sector was in a state of "shrinking or stalling mode." Nevertheless, both of these viewpoints couldn't be further from reality.

I firmly believe that DeFi is still very much alive and thriving, showing no signs of shrinking or demise.

The concept of DeFi during the summer of 2020 has undoubtedly and thankfully evolved. It was a period characterized by excessive bribery, liquidity, and fervent discussions about yield. The phenomenon of "yield farming," which fueled the fire of DeFi Summer, eventually subsided, leading to the emergence of a handful of decentralized platforms as market leaders. Many of these platforms opted for professional "white glove" services to facilitate their expansion.

However, the sector is far from flawless. As Daniel pointed out, we are also witnessing an alarming concentration of power among a select few individuals. This situation feels all too familiar.

What sets this technology apart from past tech is that DeFi has been taken to an unprecedented level of financialization. It's less than ideal when a group of programmers dabble in the realm of financiers.

However, it is crucial to bear in mind that we are still in the experimental phase with this technology. We have not yet fully grasped its optimal usage, and inevitably, errors may occur.

Over the past few years, our achievements have been focused on creating resilient systems that transcend the limitations of conventional corporations, banking channels, and even geographical boundaries. Our secure system has garnered the trust of major financial and corporate giants such as Mastercard, Visa, Coca Cola, Anheuser Busch, Nike, Starbucks, BNY Mellon, BlackRock, and Fidelity. They have not only invested substantial funds but also allocated internal resources to harness this technology for enhanced efficiency.

"DeFi will continue to be challenging. It will get even harder as DeFi continues to grow."

These initial experiments and corporate explorations demonstrate the potential for DeFi to mature into a professionalized industry, proving that its market growth can be sustainable and not solely reliant on FOMO-driven dynamics.

Nevertheless, despite the widespread aspiration for absolute decentralization of all financial systems, the practicality of achieving this remains elusive, at least within our lifetimes. The most challenging aspect to comprehend is the delicate equilibrium between self-executing code and the individuals responsible for its creation.

Curves are merely an illustration: Humanity cannot be extracted from humans. However, that's perfectly fine.

We delved even deeper into the realm of decentralization during the DAO Summer of 2021. It became a reality that anyone could participate in a decentralized autonomous organization by simply following a Discord link, contributing their efforts in exchange for freshly minted tokens, and having a voice in the organization's decisions. However, this decentralized structure had its limitations when the founders and investors exercised their voting power, which often led us back to a more traditional corporate hierarchy.

This perspective isn't intended to be pessimistic, but rather to acknowledge that DeFi is operational, even though it may not always appear that way. The truth is, DeFi will persistently face challenges, and these challenges will likely intensify as DeFi expands and intersects with individuals who haven't been sufficiently self-driven to explore the world of cryptocurrencies.

On one side of the crypto divide, we find individuals advocating for the preservation of the conventional economic, financial, and corporate structures. In this traditional system, the Federal Reserve maintains authority over the money supply, banks wield control over monetary assets, and the government dictates investment options, limiting our choices. Furthermore, major publicly held corporations have considerable control over our data, leaving us with limited recourse to address these concerns.

On the opposite end, we find The Degens, also known as traders, builders, and protocol creators, who seek to decide on every matter through token count and steer the world's course with wealth generated through computer code.

In actuality, we are likely to settle somewhere in the middle.

There is still an enormous amount of value locked in real estate, private and public companies, and debt instruments, all of which require proper accounting, trading, and collateralization. However, the transition to the blockchain is an inevitable trajectory for the world's financial landscape.

And as we witness a greater influx of assets being represented on-chain, DeFi will be readily available to offer loans, liquidity, and transparency. It's worth noting that Curve CEO Michael Egorov himself availed loans through the system, and the entire world had the opportunity to become aware of his potentially risky debt because it was all recorded on the blockchain. Numerous individuals openly expressed their concerns about it. In which other financial sector would such hazards be made publicly accessible and visible?

The rapid and triumphant expansion of the DeFi ecosystem and technology has brought about a significant paradigm shift in the financial landscape. With its core values of transparency, efficiency, disintermediation, and self-custody, DeFi has the potential to establish a new standard across the entire financial system. Failing to adapt to this disruptive force could leave traditional banks at a disadvantage, as the ongoing innovations in lending, borrowing, and insurance within the DeFi space present greater opportunities for broader participation among individuals.

The experiments may not be flawless, but that's precisely their nature - experiments. Despite the unsettling Curve situation, the shift towards decentralization requires us to entrust the market to find its course. We should allow the protocols, teams, and systems to implement the necessary adjustments.

DeFi is far from dead or dying; in fact, it is now truly emerging into the spotlight.

Source Coindesk