The Federal Reserve Bank of St. Louis released a report on the advantages and risks of deploying DeFi protocols in the financial infrastructure.
Decentralized finance may lead to a paradigm shift in the financial industry and a more robust, open, and transparent infrastructure #DeFi https://t.co/XJ5B5wVUZS pic.twitter.com/3yYT2ZQBva
— St. Louis Fed (@stlouisfed) February 9, 2021
The study is titled \”Decentralized Finance: On Blockchain- and Smart-Contract-Based Financial Markets\”. It notes that DeFi protocols could bring innovations thanks to properties such as accessibility, composability, efficiency, and transparency. At the same time, their vulnerabilities in smart-contract security and limited scalability are highlighted.
\”DeFi has the potential to create a truly open, transparent, and immutable financial system,\” noted Fabian Sher, professor at the University of Basel, author of the paper.
In terms of accessibility, DeFi could level the playing field for access to financial services, the expert noted. This is achieved through low infrastructure requirements and the actual absence of discrimination risk due to the anonymous nature.
Smart contracts can boost the efficiency of the financial system through faster transactions compared with traditional bank transfers, which can take several days.
Sher argues that DeFi protocols also help reduce \”risks of financial crashes.\” The accessibility of current and historical data represents a significant improvement, since information is currently dispersed across a large number of different bases or is not accessible at all.
Another advantage of DeFi protocols is their composability. The expert believes that the ability to assemble them like Lego bricks \”creates unprecedented interest in open financial engineering\”.
The ability to compose also carries a risk of increasing dependencies. As more products interact and integrate, they become more vulnerable to other products and undermine the expected transparency, the expert says.
The economist also mentioned vulnerabilities of smart contracts.
\”Coding errors could potentially allow an attacker to siphon funds from a smart contract or render the protocol unusable,\” explained Sher.
In conclusion, the St. Louis Fed economist offered an optimistic outlook on addressing the current issues.
At the time of writing, the value of assets locked in DeFi protocols approached $40 billion, according to DeFi Pulse.
As a reminder, CipherTrace analysts estimated the losses from DeFi sector hacks in 2020 at $129 million.
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