The St. Louis Federal Reserve, one of the 12 regional banks of the US central banking system, has published a new report analyzing the potential of decentralized Finance (DeFi).
DeFi is an all-encompassing term describing a push to automate and remove middlemen from traditional financial services like trading, borrowing and lending, derivatives, and insurance.
Fabian Schär, a professor at the University of Basel who specializes in distributed ledger technologies and fintech, writes in the paper that while DeFi is still a niche and small market, the industry is growing fast.
He illustrates the nascent industry’s rapid growth with a chart that reflects the rise of DeFi-locked USD and Ether (ETH) assets from 2018 to 2021.
“The spectacular growth of these assets alongside some truly innovative protocols suggests that DeFi may become relevant in a much broader context and has sparked interest among policymakers, researchers, and financial institutions.”
The report says the DeFi ecosystem can increase the efficiency, transparency, and accessibility of the financial infrastructure and create unique new services.
Despite these opportunities, it points out that the new technology comes with risks.
“Smart contracts can have security issues that may allow for unintended usage, and scalability issues limit the number of users. Moreover, the term ‘decentralized’ is deceptive in some cases. Many protocols and applications use external data sources and special admin keys to manage the system, conduct smart contract upgrades, or even perform emergency shutdowns.”
Still, if these issues are addressed, Schär writes that DeFi could transform the financial industry.
“DeFi may lead to a paradigm shift in the financial industry and potentially contribute toward a more robust, open, and transparent financial infrastructure.”
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