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The decentralized finance (DeFi) sector has been growing strongly ever since it blew up in mid-2020. However, two years later, it started struggling, causing many to become concerned for its future, and even assume that it might implode like other crypto lenders in the past. However, Robert Leshner, the CEO of Compound Labs and founder of Compound Finance, says that he is not worried.
What makes DeFi different?
In a recent interview, he noted that DeFi protocols are, by design, completely opposite of centralized platforms that are imploding right now. They are radically transparent, and it is easy to see what is happening at any time. More importantly, however, he said that DeFi protocols operate based on open-source code that “can’t change its mind on a whim.”
Leshner stressed that there is a common misconception about DeFi, especially among outsiders from the DeFi sector. To them, any company “doing finance with Bitcoin nearby is DeFi.” However, this is not the case, as a project can only be true DeFi protocol if it functions out in the open, autonomously.
DeFi protocols, such as Aave, MakerDAO, Liquity, and Compound itself, are the most direct parallels to companies that have been struggling lately, such as Voyager, BlockFi, and Celsius. When it comes to DeFi loans, they are extended against collateral. So, if the collateral loses value and it cannot cushion against the debt, it gets sold to close the loan. This is something that is a part of the way that DeFi lending protocols work. It happens autonomously, through the code, with no centralized authority to call the shots or try to keep the loan open.
It is simply a part of the deal that the borrower makes and needs to be aware of. Unfortunately, the current state of the market is not great, and in mid-June, it took its sharpest downturn in a long while. As a consequence, it saw over $300 million in liquidations, and that’s only within 3 biggest lenders out there.
Can DeFi survive the volatility?
Naturally, no one wants their collateral liquidated overnight, which is why it is extremely important for DeFi participants to monitor the market and stay aware of its volatility. However, it is important to note that, while this did happen — it is the way the protocols are supposed to work. In other words, nothing went wrong with this technology, as it is simply following the protocol that was created in case something like this happens with the prices.
Leshner pointed this out as well, noting that this is the project’s way of transparently managing risk. He once again stressed the importance of transparency, noting that people don’t have to wonder what DeFi operations are up to. All deposits, loans, and even the exact terms of every loan are always transparent to everyone, and always visible and viewable on-chain.
It is important to note that DeFi is not indestructible, and if the crypto market sinks at extreme speeds as it did in March 2020, even liquidations might not be enough to keep the balance within the protocols. However, if the market is falling steadily over numerous months, then the system will take care of itself, as that’s what it was created to do.
To learn more visit our Investing in Compound guide.
Ali is a freelance writer covering the cryptocurrency markets and the blockchain industry. He has 8 years of experience writing about cryptocurrencies, technology, and trading. His work can be found in various high-profile investment sites including CCN, Capital.com, Bitcoinist, and NewsBTC.