As almost every aspect of society begins to transition into digital spaces and adopt new forms of technological innovation, decentralized finance (DeFi) is becoming an increasingly relevant topic of conversation. Like the name suggests, DeFi refers to a decentralized financial system that is globally accessible via the internet. DeFi takes away the need for a middleman in making transactions, giving users visibility of where their money is going at all times. Markets are always open and removed from the confines of an institution or authoritative entity. While the refreshing changes that DeFi introduces might sound too good to be true, the benefits that DeFi promises also come with an expense that should not be overlooked: privacy.
The biggest privacy concern arises from the fact that DeFi places a large responsibility to maintain privacy on the users themselves. What many fail to realize is that the role of a traditional financial middleman is to not only handle money during transactions but also to protect private information. Without the arguably safe space that financial institutions provide to make transactions, individuals are forced to take steps to protect themselves in the decentralized system.
Many cryptocurrencies like Bitcoin are not, and don’t claim to be, anonymous payment networks. DeFi operates on a level of transparency that most people are not used to. Transactions using cryptocurrency are traceable, permanent, and public. Specifically with Bitcoin, the IP address an individual uses to make a transaction is not inaccessible by any means. After a Bitcoin address is used once, it is permanently stored in the blockchain and tied to all future transactions that use the same address. Even more alarming, users are typically required to reveal their identity during transaction processes, compromising the anonymity of their unique Bitcoin IP addresses. Though venturing into the world of DeFi seems to present a simple narrative of greater convenience and accessibility, there are countless nuances and complexities that make the whole process much more risky than newcomers might have originally expected. There are many technicalities about DeFi that are not intuitive and require a substantial amount of proper research before making a safe first transaction.
It is alarming that the pace of DeFi’s growing influence is so fast-paced because many of the issues it presents are not addressed or solved enough in depth. People are investing in all sorts of cryptocurrency before they even educate themselves on how to manage private keys properly. Coupled with the lag in robust protective regulation, the general lack of awareness for DeFi’s threats to privacy inevitably results in large populations of users that are vulnerable to attack. Though some progress has been made at the state level to set standards for blockchain, there is a greater need for industry standardization at the international level. Additionally, the rapid expansion of blockchain technology in many industries is not met with sufficient safety protocols. As such, cybercriminals are aggressively taking action to target both users and exchanges of cryptocurrency in its under-secured state.
On the flip side, there are some aspects about DeFi that are directly beneficial to protecting the privacy of users. When comparing the decentralized network that DeFi uses to a centralized one, DeFi’s “peer-to-peer” model is preferable because it prevents a “single source of failure”. In other words, when banks or financial institutions are victim to data breaches, all of their clients’ private information is compromised whereas attacks on a decentralized system would only impact a very small section of the network. While banks have many more existing security protocols set in place, the growing prevalence of privacy-threatening cyber crimes is causing greater distrust in financial institutions and organizations. According to IBM’s 2021 Cost of a Data Breach, there has been a 10% increase in the average total cost of a data breach from 2020 to 2021, rising from $3.86 million to $4.24 million. These statistics support the argument that privacy will never be a non-issue regardless of the financial system set in place. With that logic, the discussion over privacy shifts entirely. Rather than asking if a system protects user privacy, the question becomes which system protects privacy better. While the responsibility of maintaining privacy is attributed differently in each system, DeFi is unique because it offers unprecedented transparency. Clients are most likely unaware of how their banks are keeping data private. Meanwhile, DeFi creates an environment that keeps users engaged and participatory in the privatization of their own information. Whether it’s using multiple wallets for cryptocurrency transactions or using new addresses when receiving payment, there are many guidelines users can follow to protect important data from getting leaked.
After analyzing the privacy risks and the potential benefits associated with DeFi, it is safe to conclude that the problem is not that DeFi makes protecting privacy impossible, but that too many people are not fully informed about the implications of adopting DeFi. Rather than breeding distrust among crypto communities, experts and well-informed participants should aim to spread greater knowledge on how to protect privacy effectively. Additionally, there should be a greater push for privacy regulation and protective protocols for cryptocurrency usage. If users are more cautious about using cryptocurrencies and engaging in DeFi, there are a variety of unique benefits that can protect user privacy arguably better than any centralized network.