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Decentralized Finance (DeFi): Vanguard of Financial Revolution, Assessing Opportunities, Bottlenecks, Compliance

Decentralized Finance (DeFi): Vanguard of Financial Revolution, Assessing Opportunities, Bottlenecks, Compliance

Decentralized Finance (DeFi) has emerged unscathed from the misdeeds and bad trades by centralized crypto entities that led to collapses due to the unmonitored control of off-chain capital. In 2022, multi-billion dollar bankruptcies, fraud allegations, and plunging crypto-asset prices characterized CeFis, which enhanced the value of DeFi’s decentralized-first purist approach. DeFi is shedding its repute as an unsustainable idealism, and with the industry climbing out of the harshest crypto winter, there are opportunities, bottlenecks, and compliance to assess in this sector in 2022.

Real World Using DeFi

A push towards real-world assets unifies traditional finance and DeFi, paving the way for multi-trillion dollar credit markets into the decentralized finance ecosystem. Such integration thrives on the strengths of both sectors. Private-equity firm Hamilton Lane teamed up with digital asset issuance firm Securitize in a bid to tokenize $2.1 billion on the Polygon network. Singapore’s central bank, MAS, unveiled Project Guardian, a pilot program to tokenize bonds and deposits that can be used in numerous DeFi strategies. Philadelphia-based Huntingdon Valley Bank partnered with MakerDAO, and in the first commercial loan participation between a US-regulated financial institution and a decentralized asset, the protocol connected its native stablecoin DAI to traditional finance. The inclusion of real-world assets ramped up the DeFi industry’s liquidity, offering a novel asset class for investment yield while providing benefits like lower investment minimums, enhanced transparency and security of blockchain, increased access through fractional ownership, and less exposure of the investment yield to crypto volatility and serving non-crypto businesses and customers. Tokenizing RWAs has no limit, according to Matt Henderson, the Chief Strategy Officer of Aurora Labs.

Deal With DAOs

Decentralized autonomous organizations (DAOs) endorse the idea of collective governance through on-chain voting, democratizing management structure by eliminating centralized hierarchies. It focuses on increasing investor flexibility and diversity of funded ideas, but DAOs are not flawless, with privacy issues, power inequalities, and treasury management being sticky subjects. Henderson believes that “real-world businesses have searched for the ideal ways to organize and govern themselves, and none have settled on rule by mob.” The best approach that he has seen so far would “map analogously to a corporate Board of Directors, where the token holders vote periodically on a governance council (the “Board”), who then select and oversee the people who run the daily business operations of the project.”

DeFi Insurance Protocols

Calls for regulation and compliance in DeFi are growing louder than ever. A $3 billion loss to DeFi exploits last year alone has made security a fundamental bottleneck to the adoption and expansion of the space. DeFi insurance protocols play a vital role in protecting victims from losses and help them recover lost funds. InsurAce is providing safer Web3 insurance solutions on Aurora, paying over $11.8 million in insurance claims across 20 chains safeguarding over 140+ protocols. According to a recent report by the decentralized finance analytics platform OpenCover, DeFi insurance companies have compensated more than $34 million in claims in 2022 alone, with $22.5 million paid out during the Terra collapse, followed by $4.7 million post-FTX’s fall.

Compliance in DeFi with ZK

Zero-knowledge proofs were recently acknowledged by the United States Treasury Department, citing the viability of ZK tech across areas such as unencrypted messaging, data storage and security, next-gen file control systems, integrating with private blockchains, and more. ZK tech is useful for privacy-sensitive applications such as cryptocurrency transactions, enabling users to conduct trades without revealing their identities or details. Aurora Labs is monitoring ways to leverage this tech for the Rainbow Bridge, but its lack of adoption and the shortage of people who can address certain issues associated with it is a bone of contention. DeFi protocols need to implement a rigorous approach to compliance because experts believe that ZK-proofs allow for security against evolving threat actors. On the other hand, regulators should refrain from overreaching to avoid many mishaps.