- Defi applications represented the most significant segments in the continent’s Digital Investment, with a total transaction value of $994.40 million.
- Kenya, Nigeria, South Africa, and Ghana are responsible for shouldering Africa’s $20 billion monthly transaction volume in 2021.
- Liquidity and maturity mismatch result from disparities in the liquidity and maturity profiles of relevant entities’ liabilities and assets.
The concept and impact of Decentralized finance have revolutionized the world. At its core, blockchain technology has redefined the very functionality of several industries. However, its most noticeable accomplishment is its reinvention of the financial system. Innovators have promoted digital asset adoption by changing how standard banking systems work. Unfortunately, due to the consistent appraisal of the economic value of DeFi and applications, we have created an illusion that its demerits are minute.
On the contrary, the overzealous nature of blockchain developers and innovators has avoided achn=knwledging the negative impacts that DeFi has on society. In truth, DeFi has a destabilizing effect on not just the traditional financial system but also every other sector in the association. Remember that this article does not dismiss the accomplishments of blockchain and its applications.
The reality remains that DeFi’s successful application has led to this current disillusion. To fully embrace any new invention, we must also be willing to embrace all its faults. However, those advocating for this revolutionary concept merely tell one side of the coin. Here is a look at why DeFi has the potential to cripple the very financial system it’s trying to salvage.
The Positive overbearing impact of DeFi.
Before highlighting everything wrong with this blockchain application, we must highlight how innovators relied on DeFi.
The concept of DeFi stems from the first application of blockchain technology; crypto. Its ability to minimize human error and intervention and its immutable nature birthed several new inventions. Developers were intrigued by how Bitcoin could seamlessly transact digital assets between two parties with little to no personal information on them. Soon innovators have an opportunity to redefine one of the world’s oldest industries: the traditional financial system.
Since the 1920s, industries have consistently improved, adapted and continue to evolve, yet the banking system remained unchanged. It became clear that the centralized financial system had flaws, and its implementation poorly served areas such as Africa. Thus, Defi, a monetary system in which transactions are carried out peer-to-peer and trustlessly, was a breath of fresh air to many.In Africa DeFi applications have proven their versatility, and now, Africa’s fintech industry is the prime representation of the positive impact of DeFi.
The economic value of DeFi
At least 7 out of the 11 unicorn startups in Africa implements the application of blockchain technology. The economic value of DeFi has caused a wave within the continent. Today more innovators and you g enterprenuers are diving into its vast application.
According to Statista, Defi applications represented the most significant segments in the continent’s Digital Investment, with a total transaction value of $994.40 million. Remember that digital asset adoption in Africa recently passed its decade mark. Today many industries have sought after DeFi organizations to gain a piece of the bright and possibly luxurious future.
Its first application, the crypto Industry, has also taken root within the continent. Despite its steady adoption rate, the top four countries are the pillars of its application. Kenya, Nigeria, South Africa, and Ghana are responsible for shouldering Africa’s $20 billion monthly transaction volume in 2021. Countries such as South Africa, Tunisia, Nigeria and Central African Republic have taken the next step in the DeFi application by seeking to implement a CBDC system for their respective country.
CBDC might be a slight variation of a DeFi application, but its fundamental principle has granted it an honorary mention in this article. According to the McKinsey analysis, Africa’s DeFi application will result in a 10% annual growth rate, and its effects will cause the continent’s financial revenue to reach $250 billion by 2025.
DeFi promises personalized banks, and organizations such as Yellow Card, Chipper Cahs, and many more are steadily achieving this.
Its ability to propel digital asset adoption is nothing short of revolutionary. Unfortunately, it’s its very adoption speed that worries many financial experts. Defi’s positive impacts and economic value have resulted in many individuals diving into the venture without considering the possible backlash. The demerits of Defi have catastrophic consequences if not dressed.
Underneath the “positive” impact of DeFi
There are two sides to a coin, which applies to virtually everything we do today. The vast implementation of motor vehicles caused the decline of horse ranches, and the high performance of AI led to an increased unemployment rate. Establishing a high rate of digital asset adoption threatens the value of fiat currency in every country.
Implementing new and functioning innovations always creates a tunnel vision for those participating. Likewise, the demerits of DeFi do exist and, in some cases, are already rapidly affecting economies today.
According to Blockwaorks, crack across international banking sectors are forming due to various economic factors, but its main hindrance is the high pace of DeFi applications.One of the few demerits of DeFi directly affects its first implementation in the crypto industry. It is common knowledge that liquidity and volatility are the Achilles’ heel of cryptocurrency.
Liquidity and maturity mismatch result from disparities in the liquidity and maturity profiles of relevant entities’ liabilities and assets. Such risks emerged in stablecoins, leading protocols and other Defi applications. Liquidity does not deal a fatal blow to the use of digital asset s security, but it poses a severe danger in markets instead.
The supply and demand of digital assets govern the crypto industry. Thus the higher the need for a digital asset, the lower the available crypto cons and, hence the higher the value. The collapse of the DeFi leading protocol BendDao is one such illustration.
Its inability to liquidate its security for defaulted loans due to a lack of demand caused spiral effects that led to the loss of millions. According to the co-founders, they significantly underestimated how illiquid NFTs could be in a bear market.
For those new to the concept, liquidity is the ability of a business to convert its assets to cash quickly. In contrast, volatility is the price of an asset depending on its demand.
Combine the effects of an organization’s inability to convert its digital assets to cash and the low demands, which causes high supply and low price, and it’s essentially a cooperate “death sentence.” Africa’s crypto Industry is well aware of the applications of volatility from the recent FTX Crash. Still, liquidity affects a much broader scale if an economy incorporates digital assets.
Unbothering legal risks.
Legal risks are one of the minor concerns of innovators within the tech industry. In truth, most innovators often claim that legal issues only arise after fully realizing a concept. Defi applications are mainly unregulated, causing many scammers, hackers and other illegal entities to thrive within the DeFi industry.
Privacy coins are often a heated debate among those within the Web3 community, and their utterly anonymous nature has made it a breeding ground for illegal activities. In 2022, most hackers converted stolen digital assets into privacy coins and stored them in ecosystems such as Tornado, thus wholly concealing their presence.
In truth, many can redefine the positive impacts of DeFi for their gain. The anonymous and uncontrolled nature of DeFi has given too much power to individuals. Today, most, if not all, illegal activities use Bitcoin or any privacy coin to finance their operations.
Hackers and scammers within the DeFi Industry have evolved and are no longer those random phishing messages we are used to. Today top cooperations and organizations might be the very scammers we fear. Onecoin and FTX were a reminder that DeFi is still highly unregulated and thus poses a significant risk to the ecosystem. Fortunately, since the recent incident, many have gained some insights into the demerits of DeFi.
Defi does not play fair.
One of the strategic moves DeFi platforms have made is making it appear that the ecosystem levels the playing field for everyone. Financial markets are inherently prone to economies of scale, scope, and extensive network externalities. These and other forces create pursuers for concentration despite many terming the ecosystem as a “free market entry.”
For instance, liquidity is a focal point for most exchanges and traders will always try to execute their transactions on the deepest and most liquid exchange.
This ensures the safety and some sense of security. However, it also creates the perfect conditions for exchanges to charge high fees. Note that a slight difference between $5 and $6 in transactional fees could be the difference between millions and billions. Binance has a daily trading volume of at least $8 billion. It is important to note that despite DeFi applications advocating for individual empowerment, it’s still a business first and foremost.
Governance becomes an issue.
Another demerit of DeFi is its inability to govern its application correctly. Its theoretical application makes sense, and many organizations advocate for it. Unfortunately, implementing a nationwide DeFi system is complex. For instance, the first-ever DAO raised over $150 million but faced numerous governance problems.
It was eventually delisted due to its inability to mitigate this issue: DeFi application and digital asset adoption advocate for the empowerment of the individual user. Unfortunately, in some DeFI platforms, the power one holds determined by its number.
Governance in any blockchain follows a simple principle of obtaining 51% of the entire network. Sometimes, the amount of take within the organization determines your say on the system. Theoretically, it represents a positive impact of DeFI but can practically mean some issues.
Investors who gain enough stakes within the network could easily sway the network’s decisions regardless of other views. In addition, it would be hard to impose any penalties due to the anonymity most DeFi applications have.
It is a reality that Defi’s positive impact is numerous and has practical use cases. Unfortunately, its demerits also held some power. In addition, there are multiple attempts to bring the aspect of centralization into some DeFi applications. This in itself presents both positive and negative impacts of DeFi.
Unfortunately, if we cannot deal with the adverse effects of DeFi, we could ruin the very system in place to evolve us. The economic value of DeFi still stands, but addressing its issue is also a positive way of implementing its applications.