Decentralizing Traditional Finance: Bridging CeFi and DeFiIn recent months, DeFi has become the new buzzword in the world of crypto, and the crypto news wires are full of DeFi.
CeFi and DeFi Explained
With Bitcoin’s 10th birthday come and gone, developers and entrepreneurs are now looking to take a bigger bite out of the banking industry.
Over the last 10-years, the crypto market has been largely aligned with the global banking system in the form of centralized financial services.
In fact, only a handful of decentralized exchanges have existed in recent years. It’s also worth noting that, while the platforms such as Ripple delivers a decentralized global payment system, Ripple is not truly decentralized.
These platforms all fall under the category of Centralized Financial Services.
As far as the crypto world is concerned, the main differential between “CeFi” and “DeFi” is whether a community trusts people or technology.
Using the simple differential
CeFi: Users trust people behind a platform to manage and ensure that a crypto platform remains a going concern. In other words, the area of focus is on the appropriate governance to ensure the success and viability of a platform.
DeFi: The community trusts technology and its capability to function and deliver its core deliverables. Under the current ethos of DeFi, there is no governance and the success of a DeFi platform is reflected in the community behind it.
For many in the crypto world, CeFi and DeFi provide very similar services at present, making them indistinguishable.
Currently, both CeFi and Defi platforms deliver financial services that include but are not limited to:
- Crypto trading
- Derivatives trading
- Margin trading
There are, however, some distinct differences.
AML/KYC: In the world of DeFi, platforms don’t require user information. Users enjoy anonymity across the DeFi space. This is something that regulators brought an end to across the CeFi space, particularly in regulated jurisdictions.
Cross-Chain Support: DeFi platforms are unable to support the trading of some of the larger cryptos by market cap. In the DeFi space, at present, tokens must follow Ethereum standards, though this is expected to expand…
At the time of writing, Tron has also become part of the DeFi movement to compete with Ethereum that faces capacity issues.
Adaptability v Innovation: In the world of CeFi, governance and management ensure the right level of customer services to stay on top. This is adaptability over innovation. By contrast, the DeFi world is about innovation, as technology and not people is the influencer.
Crypto to Fiat: CeFi platforms are able to support crypto to fiat and fiat to crypto transactions. This is because of the AML/KYC requirements that CeFi platforms must adhere to.
Custody: CeFi platforms require users to keep funds on the platforms providing financial services. The issue of custody puts users at risk of hacks and theft. Let’s not forget that CeFi platforms also hold personal information in addition to user funds…
Transparency: Due to the nature of CeFi platforms, there is a transparency issue. Within the DeFi space, platforms are governed by technology and, specifically, smart contracts, ensuring transparency.
The Buzz Words
As DeFi etches is existence into the crypto sphere, there are a number of buzz words that any crypto trader and investor must know…
DEX: These are decentralized exchanges that run on smart contracts. The smart contracts are encoded with instructions to execute orders on a DEX.
Innovation, innovation, innovation: DeFi is technology-driven and, as such, will continue to innovate rather than adapt to meet customer needs. At present, the DeFi space is in Rapid Innovation Mode (“RIM”).
Permissionless: There are no AML or KYX processes to access DeFi platforms and financial services. This means that users do not need to provide personal information to fund DeFi accounts or to have access to DeFi financial services. All a DeFi user needs is a wallet.
Trustless: A DeFi community does not need to trust that a protocol will deliver what it says on the box. There are a number of auditors and more appearing in the space to assess and review capabilities. Most importantly is the ability to assess and verify smart contracts that DeFi protocols have in place to deliver and execute financial services.
The CeFi – DeFi Bridge
With the DeFi market in its infancy, the first step has been to build a bridge between the CeFi and DeFi worlds.
It’s not surprising that one of the crypto market’s most well-known names is involved in bridging the gap…
Binance is amongst the innovators building the CeFi – DeFi Bridge.
Why the need for a bridge?
The goal of DeFi is to reconstruct the banking system in an open, Permissionless, and Trustless space. DeFi advocates see DeFi delivering a more transparent, resilient, and less fragile financial system.
Following all the negative news surrounding Tether, the case for DeFi has become all the more compelling in recent years.
There are some challenges, however. One of the key advantages to DeFi is one of its disadvantages in the early days.
There is no governance in the world of DeFi. Anyone is able to launch a protocol and attempt to raise funds. The lack of oversight means that many projects will boom and bust, leaving investors with material losses. Along with protocols that may not make it, there are also scams to avoid in the space.
While this is the case, there are some impressive protocols that have already garnered plenty of interest.
As the DeFi world maneuvers its way through its early years, some of the crypto market leaders need to carefully woo users across from the CeFi space. This is all the more important with the lack of DeFi awareness today.
Estimates vary on the size of the DeFi community, with the numbers ranging from as low as 400,000 to as many as 5,000,000. Both numbers are small, however, when compared with the CeFi space.
The market caps of stablecoins and non-stablecoins tell the story. At the time of writing, the market cap of stable coins stood at about US$16bn, dwarfed by the non-stable coins market cap of US$310bn.
The Key Steps
In order to fully bridge the CeFi and DeFi spaces, developers will need to bring the offerings of the financial sector to the DeFi space.
Some key steps in bridging the CeFi and DeFi world include:
- Materially reducing risks currently associated with DeFi platforms. Offering insurance, proper testing and auditing, and preventing hacks are a must. Any adverse news and the DeFi space will take even longer to establish itself as a viable alternative to the banking world.
- A marked increase in DeFi education to shift the DeFi space from niche to mainstream.
- Simplifying access to DeFi protocols. At present, there are too many steps to gain access, deterring possible early adopters.
- Build reputable DeFi communities.
The speed of innovation is working in DeFi’s favor early on.
While progressing through the key steps outlined above, DeFi will also need to deliver key financial services products to build the community.
More importantly, however, will be for DeFi to deliver what the existing financial systems are unable to deliver.
The ultimate goal is for users interacting with DeFi to not even know that it is DeFi. Many leading figures within the DeFi space see this as the inflection point.
At the time of writing, the World Bank estimates that the total number of non-banked sits at 1.7bn.
The Road Ahead
A fully functional DeFi world would materially eat into the 1.7bn, not to mention draw across disgruntled CeFi and bank platform users.
Looking at early entrants and stakeholders, Binance has rolled out a $100m Support Fund for DeFi projects on Binance’s Smart Chain.
The Fund is to drive collaboration between CeFi and DeFi.
As part of the shift towards DeFi, Binance will provide liquidity support to DeFi projects. Binance will also carry out security audits and due diligence processes to deliver some order to a Permissionless and Trustless world.
Through Binance, selected DeFi projects will also have access to Binance’s customer base, media information, knowledge education, financial management, and more. Binance may also list a chosen few.
DEX platforms require all transactions to take place “on-chain”. When considering the trades per second that centralized exchanges(Verified Exchanges) (“CEX”) execute, that’s an incredible burden.
With Ethereum currently the chain on which DeFi exists, 15 second average block times doesn’t cut it. The rapid evolution of DEX platforms has brought Ethereum to its knees. Alarmingly, the number of DeFi users dwarf in comparison to CeFi users. This means that the situation will only become more exasperated without change or alternative.
Another major issue for DEX platforms is the need for all transaction cancellations to be on-chain. That exposes the DeFi community to front running.
It’s also worth noting that many decentralized exchanges position themselves as decentralized rather than centralized exchanges.
In reality, however, the vast majority fit and fulfill the criteria of a centralized exchange. AML/KYC requirements are one simple identifier…
In conclusion, there’s a long way to go. With the guidance of the more reputable to bridge the gap, however, the road will be a shorter one to success.