The fall of FTX has prompted other industry players to come up with on-chain proof of reserve – publicly declaring wallet addresses that show user funds safe and secure. However, this has done little to restore confidence in the crypto community by large.
Although the sudden and highly unexpected downfall of FTX will be a big blow to the industry once the dust settles, DeFi and especially decentralized non-custodial exchanges will see a lot of adoption. In 2021 the total spot and derivatives trading volumes were 49 trillion and 57 trillion, respectively. DEXs comprised less than 5% of the spot volumes and 2.5% of the derivatives market. Recent developments in the Defi space, like better user experience, lower gas fees, L1 and L2 scaling, and increased liquidity and capital efficiency, will allow DeFi dapps to absorb the volumes that will divert away from CEXs.
What is Wrong with CeFi – -Centralized Finance?
Bitcoin, the first successful cryptocurrency that sparked the whole crypto industry, was built to combat the way traditional financial institutes handle their customers’ money. The 2008 financial crisis is a prime example. With customer assets in their hands, the banks and other financial institutions had leeway to leverage them for more profit. This is nothing new. This is a select few gambling with leverage, debt, and other counterparty relationships and rolling the dice on a continued bullish market that ultimately doesn’t remain bullish.
“Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.” – Satoshi Nakamoto, circa 2009
This is what is happening to the crypto industry. By and large today, most crypto-related activities, ironically, are centralized. DeFi protocols run entirely on the blockchain, where a smart contract replaces the financial institution in the transaction. At the same time, many centralized crypto projects will invest in DeFi and sell the virtues of DeFi but are, in fact, just not DeFi. The biggest players in the market (Binance, Coinbase, and the now-defunct FTX) are all centralized in nature. From crypto exchanges to VC firms to different investment vehicles – all are operated through traditional methods. Investors and users hand over their assets to the firms with expectations that their funds are safe. As centralized intermediaries, these firms can play around with the funds and invest in high-risk, high-profit ventures and other options. In short, they can gamble with users’ money, which is what FTX did. It didn’t take long for some in the centralized crypto industry to mimic the hated villains of the traditional finance world.
When the gamble fails, users take the hit, as their assets are gone, leaving them in limbo. That is what happened with FTX.
“The FTX collapse is no different than a long list of other corporate failures we have witnessed in the past from centralized entities. Enron, Lehman Brothers, and the financial crisis in 2008 all failed due to greed, incompetence, and fraud. A lack of transparency and massive leverage is a recipe for disaster. DeFi can help solve these issues in the years ahead. DeFi removes these intermediaries and replaces them with smart contract protocols built on open and transparent blockchain technology.” – Stuart McKinnon, CEO, MetaTech Capital Partners
Yes, CeFi offers several advantages if done correctly. This includes investment security (through regulation compliance), ease of management using traditional website/app interface, cross-chain movements, a wide range of services under one roof, etc.
“Not your keys, not your crypto.”
Yet, the core fact that there are middlemen and user assets are not in the actual owners’ control always makes it a risk. When cryptocurrency is left in a user’s exchange account, you are using a custodial wallet. The exchange is the custodian, and they control the keys to your crypto. Technically, you don’t have the crypto in your possession; you merely hold an IOU, so to speak, on your crypto. You hope that when the time comes to claim it, the exchange will release it. The exchange can freeze your account and stop you from accessing your assets for various reasons, including liquidity issues, platform hacks, and questionable activity issues.
This is why it is always advisable to move your crypto to a non-custodial wallet. If a platform fails, your funds are in your control and not frozen as the platform goes through bankruptcy proceedings.
Why DeFi is Better?
Satoshi Nakamoto, the pseudonymous creator of Bitcoin, sent a very powerful message encoded in the first transaction by the King Crypto: “The Times 03/Jan/2009 Chancellor on the brink of second bailout for banks”. This shows the clear intent of Bitcoin as a digital currency equivalent that is meant to protect individuals and their assets. For the first time in history, people had an alternative to relying on banks to store and transfer money.
True DeFi today offers the same core aspects of cryptocurrencies through different financial instruments and services. From DEXs to lending platforms, DeFi keeps the money where it should be: in the hands of the token owners.
Built around smart contracts, DeFi is an industry ruled by code, not by intermediaries. The most straightforward actions of transferring tokens and coins don’t require a bank or an intermediary. All that is needed is the receiver’s wallet address and a small payment made to validators to confirm the transaction on the blockchain.
DeFi also allows for novel income streams that were once only available to banks and other financial institutions. Take liquidity pools as an example. Enabling swaps through AMM-style protocols, people can deposit both tokens in a trade swap pool, providing liquidity (hence the name liquidity pool). The liquidity providers take a cut of the swap fee based on their contribution to the pool and the overall trade fee. The liquidity provider can always take out their funds anytime they want.
For lenders and borrowers, there is an opportunity as well. A lending smart contract works on the same traditional principles of taking assets from one party and lending to another against interest. However, unlike CeFi, the smart contract ensures all conditions are met, such as adequate collateral, interest yield, loan default liquidation, etc. Again, as a DeFi product, this is a one-on-one deal between two parties with no intermediaries. This is beneficial to both sides. Since there are no third parties taking commissions, the borrower pays a lesser interest fee than a CeFi service, while the lender still earns a fee.
But it’s not all about better services, but financial inclusions as well. Censorship-free, trustless, and permissionless, DeFi services are available to anyone and everyone with crypto, a digital wallet, and a cell phone. You can be in any part of the world, and as long as you have the right tokens, you can participate in any DeFi service you desire.
Lisa Loud, CEO, and Co-Founder of DeFi SAAS platform FLUIDEFI, a platform aggregating liquidity pool and yield farming data and analytics for institutional clients, believes compliant and transparent crypto is the key to the mass adoption of cryptocurrency and decentralized finance.
“As crypto natives, we believe that for our business & the cryptocurrency industry to grow, we knew FLUIDEFI had to comply with global regulations. Doing so ensures we can continue to operate and expand globally, instilling trust in investors, users, and governments. Building a crypto-regulatory compliant platform has allowed us to partner with government entities, affiliated businesses, and renowned universities, including the Government of Canada, the province of Quebec, the University of Toronto, and the University of Manitoba”, says Lisa. “Our decision has allowed us to operate more openly and transparently, which is essential for building government support. Compliance is the only way to access traditional government-regulated financial institutions and markets, which is crucial to industry growth.” Lisa Loud, CEO & Cofounder, FLUIDEFI
DeFi is the Best Option
CeFi services do have their allure, no doubt. However, services like FTX and its sister firm Alameda Research have proven, once again, that DeFi will always be better than CeFi. You shouldn’t rely on intermediaries that gamble with your money. Your tokens should be in your hands, always.
DeFi means you don’t need banks or other financial service providers. You are your own bank.