FEON WONG | LEGAL JARGON WRITER
What is it?
What if financing could be done through phones instead of banks? Fret not, it is happening now. Decentralised finance essentially means the use of a blockchain network to create financial services and products isolated from traditional financial institutions. The invention, if not brand-new interpretation of the power of technology, allows free access to people regardless of location, credit history and status. It makes sure that the transaction is beyond the control of a central party, thus, making it unmodifiable by the central party. Its potential is evident since hitting a transaction volume of $54.9 billion of stablecoin, an asset-backed digital asset, in June 2020. But what are the other pros that part users from traditional financial services or products?
What are the benefits?
Credit record and history is no longer a prerequisite to borrow money - a smartphone and internet connection is. This will relieve 1.7 billion people who lack financial service access.
Charges at traditional institutions can be expensive. People turn to decentralised finance as it can help reduce those transactional costs through eliminating the intermediaries.
With the application of smart contracts, new financial products such as flash loan, an uncollateralised loan that is only valid within one blockchain transaction, can now be made possible. Essentially, it is made available by allowing reversal of a loan transaction when the borrower defaults on a payment; it is thereby marketed as a risk-free loan.
The transition from one central server to thousands of computers is not manipulated when it comes to validating the transaction or record keeping. The technology also gained an edge over traditional financial institutions for its ability to be developed, validated and audited by anyone.
What are the risks?
Despite being a new entrant it is growing in a formidable speed, but there are still some concerns yet to be solved.
1) Regulatory Resistant
Some countries took a hard stance against cryptocurrency, for example China, while others were more lenient to its authorisation, like the US. Even so, Libra, the Facebook-created stablecoin, faced strong resistance from the regulators, financial institutions, and politicians in America. Although progress is desired, these bodies are still more concerned with the inherent unpredictable risk that could potentially affect millions of people if made widely available.
Stablecoin may well not be stable. The protocol that controls the existence of stablecoin could be flawed on its own which, subsequently, affects other users thanks to its decentralised features. DeFi also shares the same vulnerability as other technologies – it is susceptible to cyberattacks. For instance, hackers had successfully launched an attack and extracted $318,000 from bZX on its first attempt and $636,000 on its second within a few days.
Will the technology ever develop to its maturity? Will the traditional financial service providers remain popular amid these technological disruptions? It is possible but the law, which has lagged behind these fresh developments, will try to keep up. This is in order to combat any adverse consequences brought on by this technology so it can be limited within the legal framework.
LLB student at The London School of Economics | Communication Officer at Japan Society at LSE 👨💻Want to share feedback? Did we miss something important? Let us know! We would love to hear from you at firstname.lastname@example.org or simply just comment below!