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Misconception #1: DeFi will replace banks
Banks and traditional financial systems can undoubtedly be a pain in the neck, especially when trying to access lending services. There is also a risk of having your account frozen for the most fragile reasons. The idea, however, that DeFi will be the end of banks is a far-fetched myth. The collapse of the financial market in 2008 gave birth to Bitcoin, and the cross-border acceptability of cryptocurrencies make DeFi attractive, but they are unlikely to dethrone banks.
The blockchain technology that powers the DeFi ecosystem is not exclusive to DeFi, and banks can always borrow or mimic the technology. Barclays Bank in the UK has already begun the process of involving smart contracts in its payment processes. Several other banks, including Bank of America and the Development Bank of Singapore, are in various stages of testing smart contract services.
Banks are usually slow to change, but they are unlikely to sit on their hands and allow DeFi to relegate them to oblivion, not if they can copy technology as well.
Misconception #2: DeFi is safer than traditional finance
Decentralized finance is often touted as the safest financial system. The probability of human error is minimal, and users can interact directly with the smart contract. There are also several safeguards put in place to verify and record transactions. This is in contrast to centralized financial systems that leave room for both human error and manipulation. DeFi, however, offers unique risks, and some of them are irreversible.
DeFi protocols and apps are sometimes hacked and user funds are stolen. In many cases, users lose these funds permanently. With centralized systems, there are regulatory laws in place that require them to partially or fully reimburse users. Such guarantees are rare if not non-existent in DeFi.
Certik reported that over $1.3 billion was stolen in DeFi protocol hacks in 2021. 2022 looks poised to be a worse year for DeFi hacks, more than $1.6 billion was stolen from the DeFi ecosystem in the first four months of 2022 alone, more than the entire 2021.
Hackers usually exploit flaws in the code of a smart contract that often go unnoticed by developers. DeFi may be more secure from censorship, but funds are just as vulnerable to cyber threats as those in centralized systems.
Misconception #3: DeFi Guarantees Complete Anonymity
A commonly discussed advantage of DeFi is that it does not require KYC and as such users can use the ecosystem anonymously. DeFi enables the creation and trading of digital currencies on the blockchain. These exchanges and the wallets that undertake them are still recorded on the blockchain. The information is also available to anyone with access to the blockchain. If the authorities or law enforcement decide to trace the initiator of a transaction or the owner of a wallet, all they have to do is follow the trail of the money until it is deposited in a bank account.
What makes blockchain technology unique is the decentralized nature of the system that allows thousands of nodes to verify and record transactions. They then share this information with the public to improve transparency. These records do not reveal a person’s identity, but they make it impossible for one to be completely anonymous.
In February 2022, the U.S. Department of Justice arrested a New York couple for a $4.5 billion Bitcoin robbery they carried out in 2016. The duo had moved the funds into a wallet after stealing the funds in 2016. The Justice Department was, however, able to trace the proceeds from the sale of the assets to the accounts of one of the people involved. So much for anonymity.
Conclusion: DeFi is revolutionary but has limits
Decentralized finance has been one of the most successful niches in cryptocurrencies since it made its debut in 2018. With DeFi, it is possible to access non-bank populations without the need for often rigorous bank records. The ecosystem has incentivized loans and loans with appetizing APYs and low interest rates on loans. Yield farms have been a hotbed of activity for profit-seeking investors. It was revolutionary and, as is often the case with unique innovations, misconceptions about them soon flourish.
There are limits to the features and services that DeFi can offer. This makes it no less than a unique innovation. While other countries like China continue to crack down on cryptocurrencies, adopting DeFi as an alternative will continue to spur growth and misconceptions.
