DeFi Can’t Protect Your Crypto Either Not yet, at least.
Detroit, Michigan
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December 08, 2022 09:50 AM Eastern Standard Time
Authored by Amy Wilkinson, Radix.
“Not your keys, not your crypto.” If you’ve traded a token or two in your time, you’ve likely heard this phrase thrown around before. For those who haven’t, the six-word warning is often said in reference to the use of centralized financial (CeFi) products when storing your cryptocurrencies, and the contradictory position this leaves your tokens in.
With the idea that crypto was born to decentralize the financial ecosystem and remove holding power over your assets from money-hungry authoritative entities, holding your crypto on a centralized exchange or application that simply leverages Web3 to offer their services does the opposite.
The age-old battle has recently escalated thanks to the FTX scandal that felt ever-so reminiscent of traditional financial corruption, with many rattled crypto investors directing their attention towards the development pinned to kick centralized criminals once and for all: decentralized finance (DeFi).
DeFi, by nature, is exactly what crypto was built for. Following the 2008 financial crisis, Satoshi Nakamoto created Bitcoin as a new, decentralized monetary system that, if globally adopted, was intended to become a new financial system free of the flaws fiat currencies pose.
Fast-forward 14 years, and the foundations set by Nakamoto have become a fully-fledged (albeit also flawed) industry. While many projects within the space fundamentally align with Bitcoin and maintain decentralization at their core, the wild pace at which they’ve been developed has resulted in an industry brimming with talent and opportunity that just isn’t quite mapped out for global adoption.
As many have joined the scurry to pull their tokens out of centralized applications, fearful of the lack of ownership over their own holdings, there’s one fundamental issue with the migration of CeFi users to DeFi platforms:
DeFi isn’t ready for it.
Picture Eleven Madison Park – one of the best restaurants in the world – in its early days of growth. Now picture hundreds of hungry customers scrambling to the front doors of the restaurant following a less-than-satisfactory experience at an over-hyped restaurant down the street. It’s early. The lights aren’t on, the wine shelf needs a restock, the prep chefs aren’t finished, and the servers haven’t even arrived. Not only would it be absurd to expect a world-class dining experience under such circumstances, but a surge of demand in such a manner would most likely lead to an array of problems from an otherwise exquisite project and brilliantly thought-out plan of execution.
This, on a much grander scale, is comparable to what we might come to see with a mass-migration from CeFi to DeFi.
Crypto isn’t ready for mass adoption, but it will be (very) soon. Join over 10,000 others at RadFi2022 - hosted by the minds behind Radix DLT - on December 8 to find out how. Sign up for free to the virtual event here.
Your Keys But… Still Not Your Crypto?
To ensure you ‘own’ your crypto, you must ‘own’ your keys. ‘Keys’ in this case refer to a cryptographic sequence of characters known as a ‘private key’, which is generated by a decentralized crypto wallet and accessible only by the owner of said wallet. This ensures a wallet powered by decentralized software is non-custodial, meaning any big bad bosses who might have wanted to dip their mitts into your pot of honey are eradicated from the equation.
While those who migrate their crypto holdings to a decentralized application (dApp) are right to assume whole ownership over their tokens, not all is quite as it seems when it comes to using dApps.
Across virtually every smart contract platform, transactions are far from what they seem on the surface, and this is where a shift to DeFi really starts to get tricky.
Although the user interface of a product may offer the feeling of security that your tokens are ‘in your wallet’, scratch beyond the surface and you’ll have a pretty tough time locating anything recognizable.
Most smart contract languages used in DeFi today don’t actually know what an asset is. ‘Assets’ that exist on networks like Ethereum are actually just variable numbers on a list of balances maintained inside a smart contract, they’re not actually stored in a wallet.
Essentially, on most existing networks in today’s DeFi, although it might look like you’ve got X amount of X token safely stored within your wallet - there’s actually nothing in there. Instead, your wallet simply knows from where to pull the numbers.
This, in turn, makes what should be pretty simple concepts - like peer-to-peer transactions - become incredibly complex. Each time an on-chain transaction is processed, rather than one wallet sending tokens to another (as you’d expect), a message is sent to the smart contract that manages the list of balances instructing it to update the balance state for the two wallets involved.
It sounds complicated, and it is - way more complicated than it needs to be. While the industry has moved at an incredible pace to develop innovative applications, areas for improvement of the underlying technology have been neglected, meaning more and more products are being built on inadequate foundations.
The issue with how tokens exist on current networks cuts far deeper than inefficiency though.
Having such intricate, long-winded, and convoluted processes for what should be a simple A to B transaction increases the risk of exploits and hacks within the crypto space. Since the set-up of a smart contract on networks like Ethereum boils down to how its developer has built it, the existing architecture for transactions on a decentralized network means the entirety of a financial ecosystem is left in the hands of developers. This, paired with the issues developers face working with programming languages like Solidity creates room for a number of opportunities for exploits and hacks that can leave you high and dry. This isn’t even sustainable for the few using it right now – it certainly won’t be for a global economy.
Decentralized Exchanges Can Be as Risky as Centralized Ones
One of the major problems tied to developer dependency lies within exchanges.
Exchanging cryptocurrency on a decentralized exchange (DEX) should, in theory, be quite simple. However, as transactions on smart contracts do not actually involve "sending" tokens from one account to another, DEX users require their wallets to follow the same steps as above, only, with the additional need for two smart contracts interacting with one another to actually record the exchange of tokens. There’s one big problem here though: smart contracts don’t know how to do this.
A solution was provided to remove this bottleneck, but it opened the floodgates for hackers.
If you’ve used a DEX before, you’ll be familiar with the step that asks you to approve the transaction you’re about to make before it goes ahead. With the complexities that come from smart contract limitations, for DEXs to fulfill a transaction, they require your permission to spend your funds for you with the expectation that you’ll receive back the token you requested in exchange.
Unless users opt-in to cap the limit they’re allowing the smart contract to spend, when these spend approvals ask a user to authorize the smart contract’s spending of those tokens, they’re often giving access for the smart contract to spend an infinite amount of the user’s holdings of said token.
With many top-tier DEXs you can expect the platform to do as it promised - provided the smart contract is implemented correctly. But, DEXs can be built by anyone who has the know-how - and when it comes to picking one from the bunch, there are a lot of them out there. While the process might feel decentralized, when you click ‘approve’ you’re essentially giving the DEX, the smart contract, and the often anonymous developer the ability to literally drain your wallet.
Apply that logic to almost any other form of trade that currently exists, and the idea is completely ludicrous. It’s like giving Walmart access to your bank account when you buy a carton of milk.
Crossing our fingers and hoping for the best like this is never going to be enough to support the $400 trillion industry that is global finance today, or even begin the drive to mass adoption of DeFi.
Tomorrow’s DeFi is Not The Same As Today’s
While the picture this paints might not be pretty, it doesn’t actually represent real DeFi.
Radically improving a global economy is not an easy feat, nor one that can be accomplished overnight. While many of the products we’re currently armed with in Web3 might not convince us to upshift & move our entire life savings to Web3 just yet, there are innovations across the industry that are starting to provide the infrastructure that DeFi actually needs – the future that finance actually needs.
Take Radix - a layer 1 smart contract platform embedded with the world’s first “DeFi engine” virtual machine built with the intention of obsoleting traditional finance. Projects like this have long addressed the issues preventing Web3 and DeFi from scaling, and have spent the best part of the past decade building technology designed at the core to enable a functional and radically better future for DeFi.
Thrusting the responsibility to secure an entire financial infrastructure onto developers isn’t good for anyone – nor is the attempt to build a novel financial system that doesn’t know what assets are.
Smart contract languages like Scrypto – Radix’s developer-first programming language – enable developers to seamlessly build code without having to spend all their time worrying about the underlying architecture. For the first time in crypto, this would allow Web3 developers to build innovative features fit for purpose on a global scale.
In an asset-oriented paradigm like Radix’s, assets like tokens are native to the network. Unlike Ethereum, Solana, and most other networks, this removes the complicated and risky process of sending, receiving, and exchanging assets because transactions on Radix work exactly how you’d expect them to.
If the crypto industry is ever to globally scale, it needs to be rebuilt.
Too many crypto projects have flown to market without effectively addressing the technology needed for DeFi, leading to devastating hacks being seen time and time again across the industry. While the industry learns from its mistakes and evolves to the next phase of evolution, developments like Radix that have been years in the making are two steps ahead – laying the foundations for better global finance to finally exist.
In 2023, after 10 years in the making, Radix plans to launch smart contracts live on its public network. To find out more about how Radix plans to radically change the future of finance, join more than 10,000 others at RadFi2022 on December 8. Sign up for free to the virtual event here.
DeFi is young. While the kinks haven’t been straightened out yet, the critical problems with central governance over independent finances are only growing. DeFi has some work to do, but the global opportunity it will provide for everyone can’t be ignored any longer, and with projects like Radix redefining the landscape, it won’t be.
Want to learn more about Radix? Visit the website here.
DeFi needs to be better - and it’s about to get radically better with Radix. Get your free ticket to join RadFi2022 on December 8 and learn what the future holds for decentralized finance. Find out how.
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Amy Wilkinson
