SMART CONTRACTS AND
DECENTRALIZED FINANCE (DEFI)
An Overview of Blockchain –Based Financial Systems
Khuzaima Saeed
WHAT ARE SMART CONTRACTS?
• Smart contracts are self-executing programs stored on a blockchain that automate financial agreements when
predefined conditions are met. They eliminate the need for intermediaries (like banks or brokers) and ensure
secure, transparent, and immutable transactions. Once deployed, they cannot be altered and run on blockchain
networks like Ethereum (EVM), Solana (eBPF), and Hyperledger (Fabric chaincode). Smart contracts use gas
fees for execution, and popular programming languages include Solidity, Vyper (Ethereum), and Rust (Solana).
• Key Security Risks:
• Reentrancy Attacks: Exploit smart contract functions to withdraw more funds than allowed.
• Integer Overflows/Underflows: Faulty arithmetic logic can lead to unintended fund transfers.
• Oracle Manipulation: Fake data inputs can cause incorrect outcomes.
• Access Control Issues: Poor permission settings allow unauthorized actions.
• Denial of Service (DoS): Large loops or gas exhaustion can halt contract execution.
USE CASES OF SMART CONTRACTS IN FINTECH
Payments & Remittances: Enables low-cost, instant cross-border payments.
• Lending & Borrowing: Platforms like Aave and Compound allow crypto-backed loans with no credit
checks.
• Insurance: Automated payouts for parametric insurance (e.g., flight delays, weather-based policies).
• Asset Tokenization: Converts real estate, commodities, or stocks into blockchain-based tokens for
fractional ownership.
• Supply Chain Finance: Automates trade settlements via programmable smart contracts.
• Digital Identity & KYC: Decentralized identity verification improves compliance and user control over
data.
IN T RO DU CT I ON TO DE CE NT R A L IZE D F I NA NC E (D EF I )
• DeFi is a financial ecosystem built on blockchain that replaces traditional banking functions (lending,
trading, payments, and insurance) with smart contracts. It removes intermediaries, making financial
services open, permissionless, and transparent.
• Key Components of DeFi:
• Decentralized Exchanges (DEXs): Platforms like Uniswap and SushiSwap allow peer-to-peer crypto
trading without intermediaries.
• Lending & Borrowing Protocols: Users can earn interest or take collateralized crypto loans without credit
checks.
• Stablecoins: Digital assets pegged to fiat currency (e.g., USDC, DAI, USDT) provide a stable unit of
exchange.
• Oracles: Services like Chainlink feed real-world data (prices, weather) into smart contracts.
• Yield Farming & Liquidity Mining: Users stake assets in DeFi protocols to earn rewards beyond standard
interest rates.
A D V A N TA G E S O F D E F I O V E R T R A D I T I O N A L F I N A N C E :
• Global Accessibility: No need for banks, credit checks, or documentation.
Transparency: Transactions are public, and smart contracts are auditable.
Lower Fees & Automation: No intermediaries mean cheaper and faster financial services.
Censorship Resistance: No government or bank can freeze funds.
Innovative Financial Products: Flash loans, programmable money, and tokenized assets.
• Risks and Challenges of DeFi:
• Smart Contract Vulnerabilities: Hacks and bugs can lead to financial losses.
Market Volatility: Crypto assets fluctuate significantly, affecting collateral and lending markets.
No Insurance or Regulatory Protections: Users bear all risks; no FDIC-like safeguards exist.
Scalability Issues: High gas fees and network congestion make DeFi expensive at times.
Regulatory Uncertainty: Governments are still figuring out how to regulate DeFi protocols.
COMPAR IS ON BE TWEE N TRADI TION AL FI NANCE AND DEFI
Feature Traditional Finance (TradFi) Decentralized Finance (DeFi)
Requires KYC, banks, and Open to anyone with an internet
Accessibility
intermediaries connection
Transparency Private and institution-controlled Fully auditable on the blockchain
Strong regulations, but
Smart contracts are secure, but
Security centralized risks (bank runs,
code bugs pose risks
fraud)
Slow transactions (T+2 stock
Transactions settle in minutes or
Efficiency settlements, wire transfers take
seconds
days)
Lower fees, but gas costs can
Cost High fees due to middlemen
fluctuate
Well-established legal Unclear regulatory landscape, no
Regulation
protections recourse for losses
FINAL THOUGHTS
• Smart contracts and DeFi are revolutionizing the financial sector by creating
open, transparent, and efficient alternatives to traditional banking. However,
while DeFi offers higher yields, automation, and global accessibility, it also
lacks the safeguards of traditional finance. Both systems have strengths and
weaknesses, and a hybrid model combining DeFi’s innovation with TradFi’s
stability may be the future of global finance.
