Decentralized Finance Faces Multiple Barriers to Widespread Adoption

Decentralized finance (DeFi) is a growing market popular with experienced crypto users. However, there are some barriers to mass adoption for the average non-technical investor.

DeFi is a blockchain-based approach to providing financial services that does not rely on centralized intermediaries but instead uses automated programs. These automated programs are known as smart contracts, allowing users to automatically trade and move assets on the blockchain.

Protocols in the DeFi space include decentralized exchanges (DEXs), lending and borrowing platforms, and yield farms. Since there are no centralized intermediaries, it is easier for users to get involved in the DeFi ecosystem, but the risks are also increased. These risks include vulnerabilities in a protocol’s code base, hacking attempts, and malicious protocols. Combined with the high volatility of the crypto market in general, these risks may make it more difficult for DeFi to achieve widespread adoption among average users.

However, workarounds and advancements in the blockchain space can address these concerns.

Regulatory concerns with DeFi

Regulation can benefit the DeFi space, but it also conflicts with fundamental principles of decentralization. Decentralization means that a protocol, organization, or application has no central authority or owner. Instead, a protocol is built with smart contracts performing its core functions while multiple users interact with the protocol.

For example, smart contracts take care of staking and trading with a DEX, while users provide liquidity for trading pairs. What can regulators do to prevent an anonymous team from increasing the value of a token before withdrawing liquidity from DEXs, otherwise known as a rug draw? Due to the decentralized nature of the DeFi ecosystem, regulators will face challenges when trying to maintain some level of control in the space.

Despite the challenges, regulation is not completely ruled out when it comes to decentralized finance. In Q4 2021, the Financial Action Task Force released an updated version of its virtual asset guidance document. The update outlined how DeFi protocol developers could be held accountable in the event of a crisis. Although the protocol may be automated and decentralized, the founders and developers could be referred to as Virtual Asset Service Providers (VASPs). Depending on the state they are based in, they may also need to be regulated.

When it comes to regulation within DeFi, platforms can also create protocols that comply with regulatory requirements. For example, Phree is a platform that builds decentralized protocols while addressing regulatory concerns where possible. One of the ways they do this is by working with traditional financial entities to create DeFi protocols that meet standard regulatory requirements. This would involve adding processes like Know Your Customer checks and Anti-Money Laundering to DeFi platforms like DEXs and lending or borrowing platforms. Additionally, making traditional finance (TradFi) compatible with the DeFi ecosystem would help expand its adoption due to the dominance of organizations in the TradFi space.

Ajay Dhingra, head of research at smart exchange Unizen, told Cointelegraph: “Incompatibility with the traditional financial ecosystem is one of the main challenges. There is a need to connect the CeFi regulatory framework with on-chain identities and real-time regulatory reporting so that Defi becomes accessible to financial institutions that deal in trillions.

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Central bank digital currencies (CBDCs) have been suggested as an answer to stablecoins after the algorithmic collapse of Terra stablecoins earlier this year. Swiss National Bank head Thomas Moser has previously said that Cointelegraph regulators may favor centralized stablecoins over decentralized coins. However, he also mentioned that it would likely take time and current financial regulations could render the DeFi ecosystem obsolete due to conflicting principles.

Security issues within the DeFi ecosystem

Security issues are a major concern in the DeFi sector, with malicious actors in the space taking advantage of vulnerabilities in bridging protocols and decentralized applications (DApps).

Adam Simmons, Chief Strategy Officer of RDX Works – the builders of the Radix protocol – told Cointelegraph: “The dirty secret in DeFi right now is that the whole public ledger tech stack has a lot of issues. well-known security threats, as evidenced by the billions of dollars lost in hacks and exploits over the past few years.

Vulnerability exploits are still taking place in the DeFi space. Recently, the Nomad Token Bridge was drained of $160 million in funds. It is also estimated that $1.6 billion in funds have been stolen from DeFi protocols this year alone. The lack of security in the DeFi space makes it less likely for new users to get involved while discouraging people who have fallen victim to protocol exploits.

In order to combat this problem, more emphasis needs to be placed on in-space verification protocols to uncover vulnerabilities before hackers can take advantage of them. There are already platforms like CertiK that perform audits on blockchain-based protocols by verifying smart contract code, so that’s a good start. However, the industry needs to see increased auditing of DApps before they go live to protect users in the crypto space.

User experience issues

User experience (UX) is another potential hurdle for users who want to get involved in the DeFi ecosystem. The way investors interact with wallets, exchanges and protocols is not an easy intuitive process, leading some users to lose their funds due to human error. For example, in November 2020, a trader spent $9,500 in fees to execute a $120 trade on Uniswap after confusing the “gas limit” and “gas price” entry boxes.

In another example, a non-fungible rock token (NFT) worth $1.2 million was sold for less than a cent when a user listed it for sale at 444 WEI instead of 444 Ether (ETH). These examples are known as fat finger errors, where users lose money due to mistakes they make when entering values ​​for prices or transaction fees. For DeFi to be widely adopted by the masses, the process must be simple for ordinary, everyday people.

However, this is currently not the case. To use a DeFi app, users must own a non-custodial wallet or a wallet in which they control the private keys. They should also back up the recovery phrase and keep it in a safe place. When interacting with a DApp, users need to connect their wallet, which can sometimes be complicated, especially when using a mobile wallet.

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Additionally, when sending or receiving payments, users must copy the addresses involved in the transactions, and in some cases, they must enter the amount of gas they wish to spend on a transaction. If a user doesn’t understand this process, they can use a low gas setting and end up waiting hours for their transaction to be sent because the gas fee is so low.

The process becomes even more complex when dealing with tokens built on networks such as the ERC-20 and BEP-20 standards. When you transfer these tokens, you must pay for the transaction with the cryptocurrency of the network it belongs to. For example, if you want to send an ER-20 token, for example, USD Coin (USDC), you will need to keep ETH in your wallet to pay for the gas, which adds more complexity to the transaction.

Developers in the DeFi space need to make the ecosystem more user-friendly for beginners and non-technical regular users of the space. Building wallets and DApps that prevent fat-finger mistakes (by automatically entering values, for example) is a good start. This is already the case with centralized exchanges, but it needs to be integrated into decentralized platforms and non-custodial wallets for the DeFi sector to grow.