DeFi and the Future of Finance

VIIRISKS

As we have emphasized in previous sections, DeFi allows developers to create new types of financial products and services, expanding the possibilities of financial technology. While DeFi can eliminate counterparty risk – cutting out intermediators and allowing financial assets to be exchanged in a trustless way – all innovative technologies introduce a new set of risks. To provide users and institutions with a robust and fault-tolerant system capable of handling new financial applications at scale, we must confront and properly mitigate these risks; otherwise, DeFi will remain an exploratory technology, restricting its use, adoption, and appeal.

The principal risks DeFi faces today are smart contract,governance, oracle, scaling, DEX custodial, environmental,and regulatory.

SMART CONTRACT RISK

Over the past decade, crypto-focused products, primarily exchanges, have repeatedly been hacked.¹ Whereas many of these situations happened because of poor security practices, they demonstrate an important point: software is uniquely vulnerable to hacks and developer malpractice. Blockchains can remove traditional financial risks, such as counterparty risk, with their unique properties, but DeFi is built on code. This software foundation gives attackers a larger surface than the threat vectors of traditional financial institutions. As discussed previously, public blockchains are open systems. After the code is deployed, anyone can view and interact with it on a blockchain. Because ...