How AI Affects DeFi: Promises and Delusions

AI has the potential to enhance transparency and decentralization in DeFi. Predictive analytics, smart contract automation, credit scoring, and other applications look promising. However, we should realistically assess AI goals, avoid unnecessarily reducing accountability and human decision-making, and refrain from setting overly ambitious targets for easy profits.

Introduction

AI is one of the most captivating technologies in the eyes of the public. It seems to have the potential to transform many aspects of our lives, including the blockchain and cryptocurrency industry.

But we must stay rational. While AI brings hope, it also leads people into certain delusions. Only by identifying potential areas for innovation can we successfully implement AI technology.

The Potential of AI in DeFi

Let’s start by defining these two terms. DeFi is an ecosystem of decentralized financial applications built on blockchain networks. DeFi products include staking and lending, liquidity pools, and centralized exchanges(DEX).

According to the Oxford Dictionary, AI is “the ability of a computer or other machine to perform or simulate intelligent behavior.” Common AI applications in finance or trading include fraud detection software, trading bots, and even chatbots.

What connects these two technologies?

On the surface, both AI and DeFi can disrupt traditional financial systems through efficiency, transparency, and accessibility. DeFi has changed the products available to all of us, while AI influences how we interact with these products.

AI seems to have the opportunity to improve DeFi’s decision-making capabilities and risk management. But what will the end result look like? We look forward to new AI financial products and services, as well as trading algorithms and market-making mechanisms.

How to Apply AI to DeFi? Predictive Analytics

Predictive analytics uses AI techniques to analyze historical data and apply statistical models to attempt to forecast future market outcomes. Over time, AI can also improve its predictive ability through machine learning. In simple terms, this is akin to AI performing technical and fundamental analysis on behalf of traders.

AI tools have long been applied in the cryptocurrency and financial sectors, and we also see prospects for automated trading and portfolio management in DeFi.

Smart Contract Automation

AI can potentially improve the effectiveness of smart contracts through automation. For example, lending protocols can use AI tools to continuously monitor borrowers’ collateral levels and predict potential defaults before they occur. The detection results can then be fed back into the lending protocol. In this case, AI will perform functions that are difficult for smart contracts to accomplish.

Detecting DeFi Fraud Activities

The anonymity of DeFi services makes it more challenging to identify fraudulent activities, but AI can recognize patterns by observing trends in large datasets. For example, data analysis techniques can identify fake exchange trading volumes or suspicious asset liquidation behaviors.

Facilitating Loans and Borrowing via Credit Scoring

As part of the core spirit of DeFi, decentralized products require minimal human involvement from lenders. However, this means that, aside from capital requirements, DeFi products like crypto lending often have very low or no entry barriers.

Lenders can offer better rates to users with proven repayment records based on credit scores. However, introducing human biases into this scoring system could undermine the decentralized aspect.

One way to address this is by using AI credit scoring to analyze borrowers’ wallets and history, assessing their repayment potential.

Investment Advisory and Portfolio Management

Traders and investors in the DeFi market see robo-advisors as very promising. Human-like interactive user experiences can ease the learning curve for technical analysis, fundamental analysis, and advanced predictive analytics. With most blockchain transactions being fully transparent, there is abundant data for AI to analyze and utilize.

Are There Negative Effects of Combining AI and DeFi?

From a broad perspective, potential AI pitfalls are evident. AI will undoubtedly reduce the need for human labor in certain tasks, which could eliminate some jobs and, to some extent, diminish accountability. The anonymity of DeFi increases regulatory challenges, and the inclusion of non-human operations further complicates issues.

We should also consider problems arising from training AI with limited data. Compared to traditional markets, cryptocurrencies, especially DeFi, are still in their early stages, lacking long-term data support, making it difficult to establish a balanced view of the entire market.

Introducing new tools also carries security risks. The entry points of AI tools and their access to data and wallets can provide hackers with additional attack vectors. Besides open-source AI tools, other AI tools are often developed by private companies or individuals. The security of these tools depends entirely on the robustness of the security features configured by their developers.

We also need to consider the decentralization risks posed by private AI tools. The specific operation of these tools lacks transparency. You may not fully understand how AI tools are updated or what data they can access. If developers cease supporting the AI technology, your AI tools could eventually become obsolete.

What Unrealistic Ideas Exist About AI Tools in DeFi?

While the integration of AI and DeFi offers new opportunities, we must be realistic. To fully leverage AI tools in DeFi, developers should focus on areas where AI can actually make a difference. Most of these delusions have already appeared in traditional finance, making them easy to recognize in DeFi as well.

AI Can Replace Human Decision-Making

Human input is always necessary when using AI tools. Users must be trained to use AI tools correctly, which is an extremely complex process, not simply deploying AI tools into the market without guidance.

AI Can Solve All DeFi Problems

While AI can improve transparency and decentralization in DeFi, it is not a magic pill that solves all issues. Applying AI to every potential problem is neither practical nor effective and could lead to more issues.

AI Trading Systems Are More Profitable

Just look at existing centralized trading platforms(CEX)—the situation is not that simple. AI systems have advantages, but we cannot guarantee they will generate more profits.

AI Will Eliminate the Need for Trust in DeFi

DeFi has largely moved towards trustlessness, but in some cases, “trust” is still necessary. AI should not attempt to replace comprehensive due diligence on project teams or founders.

What Is the Future of AI in DeFi?

In the future, AI will undoubtedly achieve revolutionary breakthroughs. However, we cannot be certain whether these breakthroughs will be applicable to DeFi. AI clearly has the potential to make financial services more convenient and efficient, and that should be the goal of our efforts.

By using AI to improve the efficiency and effectiveness of DeFi systems in forecasting, risk management, and automation of daily tasks, we can achieve this goal. AI can also be used to enhance user experience and security.

But we should not expect quick, huge profits. If you are seeking to make quick money through AI, you will likely be disappointed. Focusing on AI’s potential is not about generating larger profits but about increasing financial accessibility and freedom for DeFi users, which is much more practical.

Conclusion

Undoubtedly, AI has great potential in DeFi. It can shift our interaction with DeFi from automating financial processes to more accurately predicting market trends.

Despite the promising prospects of DeFi AI, some unrealistic ideas need to be dispelled. As the DeFi space continues to evolve, the cryptocurrency community must remain vigilant when implementing AI, explore its potential, and avoid unforeseen issues. **$YFI $ETHFI **$FIDA