Accessibility, transparency and reliability are the most significant changes that the decentralised finance (DeFi) ecosystem aims to address. Growing in popularity and having entered the mainstream since the pandemic, the lack of commonly accepted definitions for Decentralised Finance (DeFi) indicates its evolving nature.
At this moment, an oversimplified statement indicates that DeFi utilises blockchain technology to transact, lend, borrow, invest and offer deposits on a peer-to-peer level, thereby eliminating the role of intermediaries to provide services. Blockchain technology and its uses cases currently exists in a scarcely regulated or unregulated environment which is primarily the reason for lack of institutional acceptance.
Limitations of DeFi
While there are many benefits to DeFi, there are also some considerations especially arising from structural limitations. According to SEC Commissioner Caroline Crenshaw, the DeFi market may not be as transparent as it seems. Dialogue around this is mainly focussed on venture capitalists, institutional and professional investors have significant advantages over retail investors. Another structural limitation focuses on DeFi platform and their policy where users do not necessarily have to provide their personal information. This means fundamental components such as KYC and AML which are mandatory for customer to be part of who are part of regulated financial service organisations may not be implemented or may face push back.
Finally, we have to address the limitation of interoperability that plagues both age-old regulated financial systems as well as emerging decentralised finance systems. The lack of interoperability, owing to a blockchain’s unique and independent underlying technology restricted interaction between different blockchains and were limited to only the original blockchain they were built on.
The common thread that ties productivity of assets, better user experience, scalability and maximum liquidity together is smooth and seamless interoperability across all blockchains. With an ever growing number of blockchain developers, greater interaction, interoperability of blockchain and cross-access will become a mandate as users otherwise will not be able to realise the full potential of various blockchain technologies and their benefits. Further, ultimate decentralisation can only be achieved via high interconnectedness of various blockchain technologies.
To effectively deal with this limitation, cross-chain DeFi was introduced. It aims at utilizing different blockchain technologies for higher scalability, reduced fees, greater access for users on different networks, where it will be possible to effortlessly transfer and manage wealth and information irrespective of the original blockchain. Cross-chain Defi uses “bridges” to transfer these assets across various blockchains and bear the load of most cross-chain communications.
As with several nascent and widely popular technologies, security remains a concern. While the entire DeFi ecosystem is under constant attack, it is these cross-chain bridges that have become a viable target for hackers. According to Chainanalysis, $2 billion in cryptocurrency has been stolen across 13 separate cross-chain bridge hacks, the majority of which was stolen in 2022.
In light of several such incidents, cross-chain DeFi and by extension the role it plays in interoperability is receiving the much deserved traction and several firms are currently working to create new models and evaluate successful bridge design. The future of DeFi and its ability to embed interoperability within its ecosystem, in a safe and secure manner could be a game-changer.