Decentralisation, the great promise of blockchain technology, has taken a new leap with Decentralised Finance (DeFi). This technology-fueled industry that encompasses over $1 Billion locked in crypto assets has uncovered an entirely new use case for blockchain technology. Furthermore, it has expanded the horizons of investors and speculators by allowing “traditional” financial operations (such as lending, derivatives, and others) to be decentralised using cryptocurrency.
However, despite being arguably the most talked-about topic in crypto this 2020, last week something alarming happened in the DeFi world.
Flash loans, exploits, and almost $1 Million gone.
Both attacks happened on the bZx platform, causing losses close to $1 Million. These attacks, simply put, occurred when users combined the flash loans and shorting features of the platform to borrow large amounts of cryptocurrency. The borrowed amounts were later used as collaterals to exploit the low liquidity of these platforms through positions, artificially altering the price of cryptocurrencies and allowing attackers to profit from ‘well-timed’ trades.
Diagram by The Defiant showcasing how the first exploit occurred.
Why is this possible?
The blockchain and smart contracts allow decentralised apps (dApps) to exist and sustain DeFi platforms. These platforms, being significantly decentralised, are run on the blockchain and purely on code, which makes them vulnerable to users finding ways to attack them based on their working protocols. In this regard, decentralisation suffers from precisely the problem it is trying to solve: The need for trusted parties to act as intermediaries. At least at its earlier stages.
Does this make DeFi untrustworthy?
With bZx declaring that the losses caused by the attacks won’t affect their operations and transparently disclosing the procedures, it seems like there won’t be significant repercussions to these incidents—a major relief for investors, who should see this as a call to understand the risks that come with new financial tools. The incident also brought light to the fact that, although bZx is a DeFi platform, their operation is not entirely decentralised, leaving users to decide whether they choose to place their entire trust and funds at the platform or not.
Decentralised Finance promises to help eliminate the barriers that institutions have imposed for individuals to access financial services. It promises to create conditions within which economic environments can regulate themselves. And, perhaps most importantly, promises decentralised alternatives that make good use of blockchain technology. These are all desirable traits for traders and investors all over the world, which indicates that, once the panic has passed, DeFi could resume its upward curve.
The financial ecosystem of the future? We’ll see.
Since DeFi continues to offer exciting interest rates for enthusiasts of cryptocurrency and the blockchain, these platforms will not cease to exist. There are no guarantees regarding whether regulators will take further interest in them or not. Still, a case can be made that if true decentralisation is achieved, these platforms, like Bitcoin, can never be fully regulated.
Decentralised Finance is, overall, a great use case for blockchain technology that combines fundamental qualities with the right financial incentives for users. Its applications, from betting to lending, make for multi-billion-dollar markets worldwide. It’s only natural that new technologies experience roadblocks and hacks when first tested. However, in the long run, this shouldn’t undermine the value they deliver to the industry.
To all intents and purposes, DeFi is here to stay.