Cryptocurrencies have been growing in importance in recent years as acceptance grows among major financial institutions and individuals. The digital currency markets are now generally regarded as mature since they have been characterized by relatively stable prices in recent years. Most importantly, major cryptocurrencies, such as bitcoin and Ethereum, have proven over time that they are technically sound. Investors who hold reputable cryptocurrencies can, thus, expect that their money will be kept safe as long as they take steps to prevent their wallet credentials from falling into the hands of nefarious actors.
As a result, the financial community has started to create unique financial products that are based on cryptocurrencies and smart contracts. These products have properties that are not possible with ordinary centralized financial instruments. Additionally, these financial products are helping to level the playing field by making sophisticated financial instruments that are ordinarily only available to large institutions available to everyone.
What Is Decentralized Finance?
The field of decentralized finance is a rapidly growing industry that focuses on creating financial products without relying on centralized financial institutions. Ordinary financial instruments usually rely on major stock exchanges, major trading platforms, large private banks, and central banks. In contrast, decentralized finance enables financial products to be created and traded without the assistance of centralized institutions.
DeFi also introduces new concepts that do not exist in centralized financial markets. For instance, there are DeFi instruments called “flash loans” that are taken out and returned in the same transaction. These loans enable traders to borrow large amounts of money for only a couple of seconds, but these funds are available long enough to capitalize on quick market fluctuations.
DeFi instruments are also ideal for international trades since there are fewer regulatory hurdles to participation. Traders can buy financial products without needing to go through a difficult process to obtain an account and have trades approved. Instead, trades can be placed using a rule-based program that enables traders to fully capitalize on opportunities that they discover.
How Decentralized Finance Will Disrupt Current Financial Systems
DeFi is projected to significantly disrupt the existing financial system in the years ahead. Although the financial system has been more amenable to adaptation in recent years than it was in the recent past, it has lagged behind in new technologies and shifts that have occurred in the marketplace. DeFi will fill the gaps in the existing financial system, and it will begin to gain prominence as value is added.
Currently, the DeFi industry is divided between decentralized applications that are popular among retail traders and applications that are designed for major financial institutions. Since DeFi is growing very rapidly, most major financial institutions are at least beginning to investigate how to make use of it to improve their operations.
Over time, major institutions will realize the most significant advantages from DeFi because it relies strictly on a rule-based approach to finance. Institutional investors essentially specialize in developing trading strategies that are legal within the framework of existing rules. However, their plans are often thwarted by arbitrary human operators who can sometimes refuse to disburse gains when a trading strategy was not foreseen. Expensive lawsuits that entail substantial uncertainty often then become necessary. With DeFi, smart traders face no exposure to risks of having their gains frozen since gains are disbursed automatically by programmatic algorithms.
Identity, Access, and Fraud Risks in Decentralized Finance
Unfortunately, not all actors who trade DeFi instruments have good intentions. As with what happened in the cryptocurrency markets in the early days, experts project that hackers will prey on the new adopters of DiFi.
The most substantial decentralized finance fraud risks will be in the area of identity and access management. Identity and access management in decentralized finance will help to protect against the wide range of scams that are projected to become prevalent.
Nefarius actors will attempt to use malware and phishing attacks to obtain wallet credentials for the purpose of stealing DeFi instruments. The usual host of IAM-related scams will also become prevalent in the industry, such as scams involving infiltrating an organization’s computer network, using insiders to obtain access credentials, and using fake forms to harvest account information. It is inevitable that these scams will become widespread, so people involved in DeFi at all levels need to follow established IAM best practices to stay protected.
Blockchain-Based Risk Reduction Strategies
Thankfully, effective blockchain-based risk reduction strategies have already been discovered, and researchers are improving these strategies on a daily basis. Most cryptocurrency thefts are done through identity and access frauds, so safeguarding access credentials is the most efficacious way of reducing risk. Risk reduction strategies often center around ensuring that electronic systems used to access cryptocurrencies are truly secure against the wide range of threats that exist.
Protecting wallet credentials is another major facet of risk reduction. Simply saving wallet credentials on a secure computer is not usually enough to keep a system safe. Instead, crypto wallets often need to be physically stored in an offline vault. Balances in “hot” wallets that are used in day-to-day operations should be kept to a minimum, and they should only be accessed with secure software.
There should also be many confirmations to ensure that a request to send funds is legitimate. If any irregularities are noticed, a program should block the transfer of funds. Human operators can then intervene to manually approve or deny the questionable transaction.
Why IAM Matters in Decentralized Finance
IAM is of central importance in DeFi because it makes large-scale transactions possible and helps to mitigate risk. No informed investor would put their money into financial instruments that entail a substantial risk of theft. However, since IAM methodologies have been developed to safeguard cryptocurrencies, DeFi is becoming a feasible reality.
In practice, IAM is being used by exchanges that offer DeFi products and by institutional investors who trade these instruments. However, even individual investors need to take significant steps to protect their wallet credentials.
Sophisticated adversaries know that “safe” computer systems do not exist. If an investor holds millions of dollars worth of DeFi instruments, they could be actively targeted by sophisticated teams of hackers. When large amounts of money are on the line, these hackers have been known in many cases to spend months or even years studying the computers and networks of a victim to discover vulnerabilities. Thankfully, effective implementation of DeFi identity and access management can thwart these attempts to make DeFi a feasible vehicle for large investments.
How IAM Improves Security in Decentralized Finance
IAM is the key to securely using any DeFi product. Large organizations need to rely on IAM best practices to protect their wallet credentials. In many cases, organizations also need to hire IAM professionals to make sure that access systems are secure at every level.
Individual traders can also benefit from enhanced security by using platforms that have been certified to use IAM best practices. Of course, traders also need to take steps to protect their account information. However, proper implementation of IAM will detect and intelligently respond to unusual login attempts to prevent funds from being fraudulently withdrawn.
The bottom line is that IAM is the essence of what makes DeFi secure. All types of investors need to rely on IAM best practices. As long as IAM is utilized in the right way, DeFi can be a profitable investment vehicle with a low risk of loss.