Advantages
Cutting out Intermediaries
One of the biggest criticisms of traditional finance is the number of intermediaries that add to the cost of borrowing or lending. By functioning in a Peer-to-Peer form more value can be shared with the user and the DAO that sits behind it. Removing trust also means that your personal data isn’t at risk.
Unlocking Value
Lending and borrowing protocols allow users to unlock the value of the crypto holding without having to sell or trade. The interest represents the market value of holding the asset which can either provide a passive income or a means of leveraging assets without having to sell them.
Given the composability of DEFI, borrowing and lending services represent one lego brick in a growing ecosystem of related opportunities for unlocking value.
Automation
Though there is a great deal of complexity in the DEFI Protocols that provide lending and borrowing services, the user only needs to interact with a simple interface. Automation makes the process of earning interest or borrowing funds relatively simple.
Retaining Custody
DEFI borrowing and lending services are automated by the rules within Smart Contracts which cannot be changed to arbitrarily restrict access to funds as can happen with traditional banks. When interacting with a DEFI lending service you remain in control of your funds.
Transparency
DEFI is open source which means there can be greater accountability for how the Protocol is generating the return on your deposit/collateral.
Disadvantages
Security Risks
The flipside of decentralisation is that there is no one to catch you if you fall, and with DEFI there are plenty of potential risks. The protocols themselves can be hacked or simply fail, Compound became the victim of its own mistake vastly inflating the rewards it paid to users in September 2021.
Most users access lending and borrowing services directly through Hot Wallets like Meta Mask which are online by default and therefore at significant risk from hackers. Unless the necessary personal security precautions are taken there is a real risk of losing stored funds/NFTs or inadvertently connecting with a fake or compromised dApp which can then obtain approval to move funds wherever the scammers want.
Liquidation
Cryptocurrencies remain highly volatile so there is always the risk that collateralised loans can be liquidated by a sudden market crash which can happen so fast that borrowers have no time to react.
Unqualified Risk
The simplicity with which a secured crypto loan can be arranged can lead to excessive risk, especially during periods of positive market sentiment. Users might feel that they can borrow against their funds to give them greater exposure to the market, in essence doubling down. The availability of DEFI lending without any barriers can therefore lead to unqualified risk.
Flash Loan Manipulation
Flash Loans have become like a WMD for DEFI being used to exploit and manipulate Protocol logic in order to extract whatever value they can. Some argue that the code is just doing what is written to do, others argue that Flash Loan attacks are just another form of hacking. Either way, DEFI users risk huge losses.
Rug Pulls
The rapid growth in the DEFI sector has attracted bad actors who build DEFI applications with the sole purpose of attracting users only to disappear with funds overnight – what is known as a Rug Pull.
Rug Pulls are common in DEFI because of the lack of accountability and regulation, along with the willingness of users to take significant risks searching for yield.
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