Decentralized exchange and DeFi platforms have constantly taken a hit from authorities. Most governments make crypto seem criminal, while banks and financial institutions are saints.
What is Decentralized Finance?
Decentralized finance refers to a new banking system outside the traditional financial space where code is law, and users rely on mathematics and cryptography for efficient financial processes. In most economies, centralized financial institutions control all the money in circulation and determine how much of their money citizens can use.
In the United States, for example, every transaction above $10,000 requires special approval even though the owner has everything required by the system and has earned money legitimately. Commercial banks also use the money in their possession to go into other endeavors using deposited collaterals in an almost endless round of re-lending.
With the government’s backing, these banks hardly go in for all they do and are, to some extent, tools that work to keep the citizens in perpetual suffering. A simple loan from a bank attracts high interest paid during the loan duration, and defaulters often end up in jail if they fail to meet any of the obligations, including taxes. Based on blockchain technology, DeFi offers a censorship-free alternative to the centralized financial system through the following services:
Lending and Borrowing
Borrowing in DeFi is pretty straightforward. You deposit collateral higher than the amount you intend to borrow in your preferred token, usually a stablecoin. The platform issues the loan, and your collateral gets returned automatically wherever you pay back the loan.
The most important use case for these loans is that they leave you in a position you were supposed to exit to access the funds you borrowed. You could profit at the loan’s duration if you gained on the borrowed amount and the token used as collateral goes up in value.
After the loan is repaid with a little interest, the platform pays some of the interest back to the lender of the funds you borrowed. So if I deposited $500 at a 1% interest on the due date, which you borrowed to repay $510, I would receive $5 as interest for lending my $500 to you while the platform keeps the remaining $5.
Savings and Yield Farming
DeFi savings platforms allow users to save in stablecoins and earn a fixed interest rate on the deposited amount. Some DeFi savings platforms do not promote themselves in the savings category. They provide yield farming in stablecoins which are low but could yield significant returns if you invest a considerable amount.
Other projects involved in yield farming pay users a sum for providing the money needed to facilitate transactions on cryptocurrency exchanges. The amount is often paid in a token native to the platform, such as PSR or PAN, in the case of Pandora, an exchange on the BNB Chain. If you are interested in stable yields on a decentralized exchange, you can invest in Pandora NFT Securities.
Yield Aggregation
Yield aggregation protocols arose due to the expansion of early decentralized finance projects like exchanges that offer incentives in their native tokens to encourage liquidity providers. For a short while, the title: yield farmer became popular in the DeFi space, but most of these farmers switched between DeFi projects to maximize their yields. Projects like Yearn Finance came up to resolve these issues by automating the process of moving between protocols to optimize yields. The automated yield farming process, which uses bots to find the most profitable yields, became known as yield aggregation. Pandora also offers yield farming in stablecoins and higher yields in the platform’s native token.
DeFi Exchange
DeFi exchanges use the liquidity provided by yield farmers and liquidity providers to enable the exchange of cryptocurrencies. Decentralized exchanges were some of the first and most popular DeFi applications that proved the potential and possibilities of blockchain technology. The fees were only an issue when blockchains like Ethereum had scalability issues. Still, the scalability problem has been much under control since the introduction of layer2 scaling solutions and faster blockchain networks like Solana. Pandora is a DeFi Exchange platform that rewards users for consistently using the platform.
Derivatives Trading
DeFi exchanges like Perpetual Protocol use a mechanism similar to the AMM used on decentralized exchanges to allow traders to borrow crypto to trade beyond what they originally had on their balance. It is common to find 10x, 20x, and in rare cases, 100x positions on certain cryptocurrencies on centralized exchanges. These positions could be long or short, showing the traders intend to buy or sell the crypto asset using the stated leverage.
Market Making
Institutions are gradually taking over market-making in DeFi, but the original idea allows anyone to provide liquidity in pairs to facilitate the exchange between cryptocurrency assets. Liquidity providers receive rewards in tokens for providing liquidity. Still, the volatility risk may lead to significant losses compared to holding the same asset in a stablecoin when liquidity is provided.
Stablecoins
Stablecoins are backed by fiat currencies, assets, and other cryptocurrencies but maintain a stable value due to the math and mechanisms behind them. Stablecoin issuing crypto exchanges or DeFi projects often boast of an equivalent of the asset issued out stored in the world reserve currency, the USD, in their balance sheet. Some projects use an over-collateralization mechanism to maintain a stable peg, while others use a combination of fiat and crypto or dedicated algorithms.
DeFi Insurance
The success of DeFi insurance protocols is debatable. Still, the industry remains promising, and any DeFi project that will crack it and jump over the hurdles will eventually become a behemoth in the crypto space. DeFi involves risks, but protocols have yet to find an insurance solution to cover these risks. The reason for this is unclear, but the risks outweigh the benefits.
DeFi Regulation Explained
DeFi regulation refers to the legal instructions and rules that define how DeFi should be used, the constraints while using DeFi, and the consequences of all DeFi activities in black and white. At the time of writing the article, only the US State of Wyoming has a regulation that treats DAOs as limited liability companies. Other jurisdictions have given several reasons why DeFi remains a grey area before the law.
First, the litigation needs more clarity. Except for references to electronic signatures in the National Commerce Act of 2000, which makes references to electronic signatures, the US law does not provide for an autonomous, decentralized, and self-executing agreement like a smart contract.
Second, since smart contracts run the network from across the globe, it is difficult to say which jurisdiction applies to blockchain and cryptocurrency activities.
Third, the long history of theft and fraud involving cryptocurrency transactions and blockchain technology is alarming, yet the same technology has often protected most theft cases.
Fourth, the capital gain tax, which is supposed to apply to cryptocurrencies, often needs to be more specific since cryptocurrencies are extremely volatile.
Lastly, since traditional assets do not back cryptocurrencies in the financial market, regulatory concerns often fade in the face of collective ownership, which again makes specific litigation impossible.
Is Regulation Necessary For DeFi Projects?
DeFi regulation is necessary, but it will take several years to get enough judicial precedence and background information to know what may or may not happen when it comes to cryptocurrencies on decentralized blockchains. It is important to regulate DeFi to protect users from malicious actors such as hackers and fake developers who launch projects only to pull the rug by selling off on investors before actually fulfilling their obligations.
Regulations will also guide the developers on the core obligations they have to their users while educating users on what to do in cases of breaches. Regulation will also speed up bankruptcy assets recovery and help liquidators compensate victims who got their funds locked in bankrupt projects faster.
With regulation, DeFi will be more of a serious and long-term business with fewer people coming in to make quick bucks or cash in on investors trying to build wealth. In such a stable environment, the speed of innovation will multiply, and only the best ideas will be left to survive.
Argument Against the Regulation of DeFi Platforms
The anti-regulation argument in crypto stems from the origins of Bitcoin, which was made to correct a failed financial system. Anti-crypto regulators believe that creating rules that guide a free and decentralized space amounts to a breach of human freedom. According to them, with regulation, the government will eventually come back in and stifle the space until it becomes a tool like traditional finance.
Conclusion
DeFi exchanges, DeFi platforms, DeFi networks, and DeFi projects are different ways people refer to the decentralized finance space where cryptocurrencies like Bitcoin and Ethereum are the primary medium of exchange.
The evolution of DeFi was initially ignored until Bitcoin became so expensive that centralized institutions had to find a way to get into it. The question of regulation continues today, and many analysts believe that the government and centralized institutions will do whatever it takes to bring DeFi under control. To these analysts, centralized institutions could be behind the collapse of many cryptocurrency projects to prove to users that they are unsafe.
Nevertheless, users are proving unyielding as the collapse of centralized crypto exchanges has only stirred interest in the decentralized alternative like Pandora. Given that traditional finance has survived its bad days, which were far worse than what DeFi and the crypto space have experienced, some level of regulation will Fastrack the growth of DeFi. Still, the authorities seem to be going in too aggressively, as though they want to nip DeFi in the bud.
These contents are for general information purposes only. They are not investment advice, a recommendation, or solicitation to buy, sell, or hold any digital asset or engage in any specific trading strategy. Some crypto products and markets are unregulated, and you may not be protected by government compensation and/or regulatory protection schemes. The unpredictable nature of the crypto asset markets can lead to loss of funds. Tax may be payable on any return and/or on any increase in the value of your crypto assets, and you should seek independent advice on your taxation position.
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