When designing a blockchain solution, consider these key questions:
- What is the governance model for participating organizations or members?
- What data will be captured in each block?
- What are the relevant regulatory requirements, and how can they be met?
- How are the details of identity managed? Are block payloads encrypted? How are the keys managed and revoked?
- What is the disaster recovery plan for the blockchain participants?
- What is the minimal security posture for blockchain clients for participation?
- What is the logic for resolving blockchain block collisions?
When establishing a private blockchain, ensure that it's deployed in a secure, resilient infrastructure. Poor underlying technology choices for business needs and processes can lead to data security risks through their vulnerabilities.
Consider business and governance risks. Business risks include financial implications, reputational factors and compliance risks. Governance risks emanate primarily from blockchain solutions' decentralized nature, and they require strong controls on decision criteria, governing policies, identity and access management.
Blockchain security is about understanding blockchain network risks and managing them. The plan to implement security to these controls makes up a blockchain security model. Create a blockchain security model to ensure that all measures are in place to adequately secure your blockchain solutions.
To implement a blockchain solution security model, administrators must develop a risk model that can address all business, governance, technology and process risks. Next, they must evaluate the threats to the blockchain solution and create a threat model. Then, administrators must define the security controls that mitigate the risks and threats based on the following three categories:
- Enforce security controls that are unique to blockchain
- Apply conventional security controls
- Enforce business controls for blockchain
IBM Blockchain services and consulting can help you design and activate a blockchain network that addresses governance, business value and technology needs while assuring privacy, trust and security.
What Is Decentralized Finance (DeFi)?
Decentralized finance (DeFi) is an emerging financial technology based on secure distributed ledgers similar to those used by cryptocurrencies.
In the U.S., the Federal Reserve and Securities and Exchange Commission (SEC) define the rules for centralized financial institutions like banks and brokerages, which consumers rely on to access capital and financial services directly. DeFi challenges this centralized financial system by empowering individuals with peer-to-peer digital exchanges.
DeFi eliminates the fees that banks and other financial companies charge for using their services. Individuals hold money in a secure digital wallet, can transfer funds in minutes, and anyone with an internet connection can use DeFi.
Key Takeaways
- Decentralized finance, or DeFi, uses emerging technology to remove third parties and centralized institutions from financial transactions.
- The components of DeFi are stablecoins, software, and hardware that enables the development of applications.
- The infrastructure for DeFi and its regulation are constantly evolving.
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Centralized Finance vs. Decentralized Finance (DeFi)
Decentralized finance differs from traditional, centralized financial institutions and banking.
Centralized Finance
In centralized finance, money is held by banks and third parties who facilitate money movement between parties, with each charging fees for using their services. A credit card charge starts from the merchant and moves to an acquiring bank, which forwards the card details to the credit card network.
The network clears the charge and requests a payment from the bank. Each entity in the chain receives payment for its services, generally because merchants must pay for the use of credit and debit cards.
All financial transactions are overseen in centralized finance, from loan applications to a local bank's services.
Two of DeFi's goals include reducing transaction times and increasing access to financial services.
Decentralized Finance
Decentralized finance eliminates intermediaries by allowing people, merchants, and businesses to conduct financial transactions through emerging technology. Through peer-to-peer financial networks, DeFi uses security protocols, connectivity, software, and hardware advancements.
Wherever there is an internet connection, individuals can lend, trade, and borrow using software that records and verifies financial actions in distributed financial databases. A distributed database is accessible across various locations as it collects and aggregates data from all users and uses a consensus mechanism to verify it.
Decentralized finance eliminates the need for a centralized finance model by enabling anyone to use financial services anywhere regardless of who or where they are. DeFi applications give users more control over their money through personal wallets and trading services that cater to individuals.
Decentralized finance does not provide full anonymity. Transactions do not include an individual's name but are traceable by the entities that have access, including governments, and law to protect an individual's financial interests.
How Does DeFi Work?
Decentralized finance uses the blockchain technology that cryptocurrencies use. A blockchain is a distributed and secured database or ledger. Applications called dApps are used to handle transactions and run the blockchain.
In the blockchain, transactions are recorded in blocks and then verified by other users. If these verifiers agree on a transaction, the block is closed and encrypted; another block is created that has information about the previous block within it.
The blocks are "chained" together through the information in each proceeding block, giving it the name blockchain. Information in previous blocks cannot be changed without affecting the following blocks, so there is no way to alter a blockchain. This concept, along with other security protocols, provides the secure nature of a blockchain.
Uses of DeFi
Peer-to-peer (P2P) financial transactions are one of the core premises behind DeFi. A P2P DeFi transaction is where two parties agree to exchange cryptocurrency for goods or services without a third party involved.
In DeFi, P2P can meet an individual's loan needs, and an algorithm would matches peers that agree on the lender's terms, and a loan is issued. Payments from P2P are made via a decentralized application, or dApp, and follow the same process in the blockchain. Using DeFi allows for:
• Accessibility: Anyone with an internet connection can access a DeFi platform and transactions occur without any geographic restriction.
• Low fees and high-interest rates: DeFi enables any two parties to directly negotiate interest rates and lend money via DeFi networks.
• Security and Transparency: Smart contracts published on a blockchain and records of completed transactions are available for anyone to review but do not reveal your identity. Blockchains are immutable, meaning they cannot be changed.
• Autonomy: DeFi platforms don't rely on any centralized financial institutions and are not subject to adversity or bankruptcy. The decentralized nature of DeFi protocols mitigates much of this risk.
Peer-to-peer lending under DeFi doesn't mean there won't be any interest and fees. However, it does mean that you'll have many more options since the lender can be anywhere in the world.
Advantages and Disadvantages of DeFi
Pros
Decentralized applications allow individuals to transfer capital around the world
Investor's ability to generate income
High level of security
Cons
Participation in DeFi is complex and not easily understood
High risk of fraud and scams
High level of volatility
The Future of DeFi
Decentralized finance is constantly evolving. It is unregulated and its ecosystem is riddled with infrastructural mishaps, hacks, and scams.
Current laws were crafted based on the idea of separate financial jurisdictions, each with its own set of laws and rules. DeFi’s borderless transaction ability presents essential questions for this type of regulation.
Who is responsible for investigating a financial crime that occurs across borders, protocols, and DeFi apps? Who would enforce the regulations, and how would they enforce them?
Other concerns include system stability, energy requirements, carbon footprint, system upgrades, system maintenance, and hardware failures.
What Does Decentralized Finance Do?
The goal of DeFi is to challenge the use of centralized financial institutions and third parties that are involved in all financial transactions.
Is Bitcoin a Decentralized Finance?
Bitcoin is a cryptocurrency. DeFi is being designed to use cryptocurrency in its ecosystem, so Bitcoin isn't DeFi as much as it is a part of it.
What Is Total Value Locked in DeFi?
Total value locked (TVL) is the sum of all cryptocurrencies staked, loaned, deposited in a pool, or used for other financial actions across all of DeFi. It can also represent the sum of specific cryptocurrencies used for financial activities, such as ether or bitcoin.
The Bottom Line
Decentralized finance (DeFi) is an emerging financial technology that challenges the current centralized banking system. DeFi eliminates the fees that banks and other financial companies charge for using their services and promotes the use of peer-to-peer, or P2P, transactions.
Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein.