DeFi To Widen Gap With CeFi After Stormy Year
Collapse Of Centralized Crypto Players Makes The Case For Self-Custody
By: Owen Fernau •Trends to Watch 2023
To the outside observer, if an application uses digital assets, that’s part of “crypto” — there’s no distinction between the now-bankrupt FTX and on-chain exchanges like Uniswap and Curve Finance.
For those more plugged into the space, the difference between an exchange like FTX and decentralized exchanges is crucial. It’s the difference between CeFi, applications which take custody of users’ digital assets, and DeFi, protocols which users interact with while maintaining control of their tokens.
On a practical level, interacting with established DeFi protocols, as opposed to CeFi platforms, makes it much less likely that a bad actor can embezzle funds. In the wake of FTX’s collapse, seemingly any and all centralized players in the space have endured scrutiny as crypto-participants poked, prodded, and asked for audits of whether the financial companies really had the assets they claimed to have.
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While FTX’s implosion may be top of mind in terms of CeFi’s failures, there were many others in 2022, and they were often preceded by the dreaded phrase “withdrawals paused,” as the companies scrambled to figure out ways to get customers their assets back.
Celsius, another lender which offered yields on user deposits, dropped the gate in July. About a week later, Voyager, a crypto broker, followed suit when Three Arrows Capital, the now-bankrupt hedge fund, failed to repay a $658M loan.
These failures to secure users’ assets contrasted with DeFi protocols which, for the most part, remained solvent as they adapted to changing market conditions.
Rallying Cry For DeFi
The contrast between the two systems, which look so similar to people with only a passing familiarity with crypto, became a rallying cry in 2022 for those in DeFi. The importance of differentiating the bad actors at FTX from the can’t-be-evil ethos of DeFi made it to Capitol Hill, where Minnesota Congressman Tom Emmer made the case for permissionless finance.
Emmer emphasized that individuals with concentrated power and no oversight, as John Ray, the lawyer in charge of FTX’s bankruptcy, characterized the cabal of people in charge of the company, was what crypto was invented to prevent. “That is the exact problem that open and permissionless technology like crypto and blockchain solve,” Emmer said at the FTX hearing.
To be sure, maintaining self-custody of one’s assets doesn’t guarantee safety when operating within DeFi — there are smart contract bugs to worry about, as well as badly designed mechanisms which can be exploited.
Case in point, any users securing their assets in their own self-custody wallets, wouldn’t have been able to save themselves from Terra’s collapse, which stemmed from an unsustainable economic design.
Still, while 2022 was a brutal year across markets, crypto and otherwise, it was a particularly vicious time for centralized crypto players. In contrast, DeFi and the “not your keys, not your coins” movement appear to be maturing a bit more gracefully.