Decentralized Finance applications have experienced exponential growth in 2020 with a boom in the value of DeFi tokens and their protocols. The value of DeFi locked in the Ethereum blockchain grew from $4 in August 2017, to $14.37B at the end of November 2020. Some popular DeFi applications include lending, stablecoins, decentralized exchanges (DEXs), derivatives, synthetic assets, insurance, and asset management.
DeFi offers many potential benefits, however, it also introduces a range of risks. Because it is a financial market, DeFi faces the same financial risks that have been well covered in existing financial theory (e.g. market risk, credit risk, liquidity risk, and operational risk). What separates DeFi from traditional finance, however, are the risks it is exposed to as a direct result of its reliance on its infrastructure layer, the Ethereum blockchain.
While DeFi can be based on any permissionless smart contract platform, this report focuses on DeFi on the Ethereum blockchain. Ethereum is an open-ended, decentralized, blockchain-based, public software platform that facilitates peer-to-peer contracts, known as Smart Contracts, as well as Decentralized Applications, known as Dapps.
Written by crypto asset researcher Xavier Meegan, this report summarizes 12 key non-financial risks in the Decentralized Finance ecosystem on the Ethereum blockchain.
What is DeFi?
What separates DeFi from traditional finance?
List of DeFi Risks