Blockchain and DeFi are in their infancy and have a long way to perfection
It appears that another perfect storm is forming on the horizon. This time it is going to be the next generation Internet ecosystem based on Blockchain technology, first introduced by Bitcoin system development team 12 years ago. No doubt in theory it seems to be a promising innovation.
The problem is that blockchain is being promoted as a panacea for all internet evils such as data security, privacy, network vulnerability and hacking, and ransomware. It is too early to predict its own well-being in the long run.
The danger is in the widespread adoption of this unproven innovation — except for limited cryptocurrencies movements — in the world of financial systems without proving its efficacy in the global financial network which is the backbone of the current economic order.
This time it can be a hurricane and tsunami combined, as the Internet innovation in blockchain technology is facilitating Ponzi like schemes in the name of cryptocurrencies and de-centralized financing.
Cryptocurrencies may be legitimate new form of asset, or perfectly organized deck of cards waiting for domino effect for their downfall. One has to wait and see.
Read: As Bitcoin loses steam, blockchain moving into next generation (September 10, 2021)
For the uninitiated, Blockchain is an innovative technology that can democratize the centralized and authoritarian world of financial systems. In theory, it can make transformational changes to financial dealings by creating more equitable and egalitarian fair market systems. Operating autonomously with no central control, it can reduce the cost of all financial transactions. In other words, it may look like dream come true.
What is Blockchain?
Blockchain is a software enhancement to the current internet infrastructure. Blockchain protocols mandate a few additional features to the current internet establishment.
Primarily it is a system of de-centralized peer-to-peer network architectures that communicate with one another. There is no central computer, as in the case of client-server cloud computing.
All computers in the nodes are connected to one network, and all have the same privilege as the same software is running them.
Data transmission is enabled by TCP/IP protocol as usual, but the data is cryptographically in-scripted for data privacy.
Data is stored in a chained ledger with a timestamp of the time of creation. Data chaining is used by mathematical algorithms called cryptography for keeping privacy and securing the identity of the parties involved. This concept is called hashing.
Recorded data is immutable, meaning it cannot be updated, altered or deleted from the chain.
User identity is managed by PKI, which stands for public key infrastructure technique, a tedious process that ensures the authority and authenticity of the system user.
The most important feature of this networks system is that it runs autonomously based on the software consensus algorithms and needs no manual intervention at any time.
Besides, all the network and computer operating costs are paid by individual transactions at their completion.
What are cryptocurrencies?
Cryptocurrencies, or Digital currencies are virtual currencies generated by Blockchain technology-based system.
These are privately promoted digital currencies with no governmental authorization or controls. Their value is very volatile and can swing depending on their supply and demand. Bitcoin is the first cryptocurrency. Today there are tens of thousands of cryptocurrencies valued over $2 trillion in the marketplace.
Read: Lure of Bitcoins: Greed blinds even the wise to risks (February 24, 2021)
What is DeFi?
DeFi is a buzzword for De-centralized Finance. It is an approach to develop network of systems to independently operate financial transactions that are distributed worldwide with no central control.
DeFi community is organized in the form Wallets, Exchanges, Data Miners. The Wallet is where an individual user’s asset is recorded and stored. An Exchange is the system where an individual can trade fiat currency for crypto assets and vice-versa. A Data Miner is the computer installation where the data is recorded and distributed cryptographically in chained blocks of records. All these three entities are connected by peer-to-peer secured network.
Financial applications can be developed using Blockchain technology to enable all existing financial and asset-based transactions independent of central control.
Such applications are being developed using a concept called Smart Contract.
Smart Contract is a software module, similar to internet AAP, called Dapp chain codes, developed in one of the appropriate programming languages to execute comprehensive terms, binding conditions and actions to successfully complete a transaction initiated by user.
There are several cryptocurrencies’ platforms developed using Blockchain for DeFi applications. The very first one was Bitcoin, which was followed by Ethereum.
Some of the other DeFi platforms are Avalanche, Hyperledger, Polkodot, Solano and Cardano. The popular crypto exchanges are Coinbase, Coinbureau and Binance.
ICO, or Initial Coin Offering, is the process with which cryptocurrencies take birth. Its counterpart in the DeFi ecosystem includes Altcoins and Digital Tokens.
Altcoin Tether is synonymous with Stable coin, which is proclaimed as dollar reserve supported. One Stable coin is equivalent to one US dollar in the crypto world. However, there is no GAAP accountability, transparency, traceability, or oversights on such claims.
Recently US government regulators required basic identity to be captured by the exchanges for trading in cryptocurrencies. This regulation is called KYI, or “know your customer,” AML — “anti-money laundering.”
There are many fault lines in this DeFi ecosystem. It is worth highlighting a story that came out in media on Tether-Stable coin issued by Tether Holdings, an offshore company. The company has issued over $66 billion worth of Tether as of now. The company officials are not able to positively demonstrate its reserve holdings to US authorities in New York. The crypto community is afraid that if investors run for their money, the system can collapse, and investors will be left high and dry.
A recent IMF research paper was critical of such assets being sold under the shadow of cryptocurrencies to unsuspecting investors from thin air.
It may be pointed out that there are many crypto pundits and gurus who are hyping cryptocurrencies, including the one in question, Tether, through YouTube and similar media platforms on a regular basis.
Read: 10 Reasons the Cryptocurrency Bubble Is Bursting (May 24, 2021)
The investors should be aware of the danger inherent in this innovation. It is a potential bubble that can not only devastate the crypto investors, but also affect normal financial system worldwide. The cryptocurrencies liquidity relates to some of the major international banks directly or indirectly.
To conclude, if the bubble bursts, it is again the technology, a devil incarnate in the form of DeFi protocol. Blockchain and DeFi are in their infancy and have a long way to perfection.
(The author is neither an opponent nor proponent of the DeFi ecosystems. He is a technology enthusiast and curious about the efficacy of such transformational changes. The views expressed here are based on his own readings and publicly available research papers and documents.)