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Decentralized finance (DeFi) is the most exciting and powerful application of distributed ledger technology. Through the power of blockchain technology, it promises an autonomous financial ecosystem that’s outside the control of individuals, entities, and regulators.
DeFi is growing fast. Today, hundreds of projects exist, and many more are in the works. But, despite the obvious advantages of DeFi, hundreds of thousands of crypto users still use centralized platforms that are managed or controlled by a central entity.
Decentralized Finance vs. Centralized Finance
Centralized finance (CeFi) is the traditional market structure where centralized entities control the access and movement of funds. It is dominated by centralized entities (companies, governments, organizations), which define and control the system. These entities can exercise extreme control and choose who they work with. They can censor or ban and can also be censored or banned.
In CeFi, centralized firms act as middlemen. This allows them to exercise significant control over the user’s funds. Banks are a perfect example.
“If you define centralized,” says Warren Whitlock, Founder and CEO of Stirling, “everything has to go through one hub. If I want to send you money, the very simplest of financial transactions, I send it to the bank, and the bank sends it to you…If you have a bank and I have a bank, then they have to get along.”
In the crypto space, centralized finance entities may offer similar services to banks. But as Wendy O, SoCal Crypto Meetup Host and Youtube Crypto Educator, says, “they’re not really banks, because there is no consumer protection. They’re not operated by these very strict entities that have to apply for licenses and conform to regulation.”
DeFi, at least true DeFi, is the complete opposite of CeFi. It introduces a peer-to-peer approach to finance that brings more power to the hands of the user.
In DeFi, there is no central authority to control and coordinate matters, or to control access to funds. Therefore, it is more resistant to censorship and regulatory action than CeFi. Users also have control of their funds. And since DeFi transactions take place on blockchains, DeFi is transparent.
“When we talk about DeFi, we’re looking at protocols, the customers, clients, having control over their funds to an extent… DeFi is like you’re your own bank to an extent,” says Wendy O.
“When we’re using blockchain technology, everything’s on-chain; for the most part, you can see it unless there’s a cash deal out of the bag, or, you know, sometimes there’s OTC deals that are done.”
But despite these benefits, many people continue to choose centralized protocols.
Centralized finance appeals to the regular person more than decentralized finance does. Even in crypto, which was initially built to be decentralized, most people trust CeFi protocols with their funds.
The biggest reason for this is that people feel safe putting their money into Centralized Finance protocols. On the other hand, they consider DeFi projects to be riskier, especially when it comes to investments.
This is not far from the truth. Many DeFi projects offer unrealistic rewards in order to attract as many investors as possible. This model may work in the short term but is unsustainable in the long run. It makes investing in DeFi protocols very risky, even more so considering that many DeFi projects fail.
Such risk is too high, even for experienced investors. Wendy O explains why she had preferred centralized platforms like Celsius and Voyager:
“One of the reasons why I would do that was because the rates they were offering, like the 8%. That’s not necessarily high. A lot of the staking platforms and the farming pools on decentralized protocols were giving back 100% APY, 50%, 40%, etc. And to me, that was super, super risky. So I feel like a lot of people felt safe because we were looking at the lower rates.”
CeFi is also generally more convenient than DeFi. Take crypto exchanges for instance. Centralized exchanges (CEXs), like Binance, offer a single platform where the user can find most of the tokens they need. On a CEX, traders can easily and conveniently swap tokens from different chains.
But that isn’t the case with decentralized exchanges (DEXs). A DEX usually limits the user to tokens compatible with the blockchain on which they have been built. Therefore, if a trader wants crypto from different blockchains, they have to use multiple exchanges or use bridging platforms, which takes a lot of time.
When DeFi Isn’t Truly Decentralized Finance
There is another problem on top of CeFi’s colossal appeal. Most DeFi projects aren’t truly DeFi. Instead, they have some CeFi characteristics.
Tone Vays, former Wall Street Quant and founder of FinSummit, says, “Everything in the DeFi space is pretty much the same as the traditional finance space. It’s just different people doing it. And they’re using different terminology. Instead of the word database, they’re using the word blockchain, for example.”
It’s easy to see why. A lot of DeFi protocols aren’t truly decentralized. They may operate autonomously, but like centralized entities, they have actual control oversight by a group or an individual. Projects have teams behind them, which essentially act like boards or development groups, holding meetings and making key decisions to determine their direction.
This has some significant implications. For instance, a project will suffer if they lose a key figure or decision maker. It also leaves the project somewhat vulnerable to regulatory action because regulators can affect a project by singling out key individuals.
True decentralization is needed to create successful DeFi projects that will revolutionize the space.
“It’s almost like the internet itself, where the internet helped a lot of companies, but it’s the same company,” says Tone, “Netflix is the same company as Blockbuster. They just utilized the internet and took Blockbuster out. Amazon is mail order, only they utilize the internet and they became one of the biggest companies in the world.”
One project that’s taking decentralization seriously is Sifchain. For one, it’s building an Omni-Chain decentralized exchange that will allow users to swap their favorite tokens in one place. Once ready, this project will make DeFi much more convenient.
But perhaps more important is that the project is run internationally as a decentralized entity. It’s not really based in one place with a home office address. Instead, the front end for the DEX and the node structures are completely decentralized.
This process is ongoing and innovative solutions are being developed and improved upon every day. Even within the blockchain ecosystem itself, projects that aren’t innovating are quickly outpaced by competitors that can do more. This has created an incredibly fast-paced environment that continues to create some of the most unique and revolutionary ideas seen this century.