Defi Risks and Crypto-asset Growth

What Decentralized Finance (DeFi) issues may dampen associated interest in crypto-assets by undermining its promises of lower costs and risks compared to traditional, centralized financial intermediaries? In their June 2021 book chapter entitled “DeFi Protocol Risks: the Paradox of DeFi”, Nic Carter and Linda Jeng discuss five sources of DeFi risk:

1. Interconnections with the traditional financial system.
2. Blockchain-related operational issues.
3. Smart contract vulnerabilities.
4. Other governance and regulatory concerns.
5. Scalability challenges.

A general objective of DeFi is automating rules for behavior in a publicly available financial system, eliminating human discretion from financial transactions/contracts. In practice, however, core DeFi protocols retain some human oversight to address unpredictable problems as they emerge, but such retention allows incompetent or malicious governance, administration and validation (see the figure below). Based on review of the body of research and opinion, they conclude that:

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