Over the last decade, crypto finance was largely dominated by centralized institutions, organizations acting as intermediaries and custodians. Although centralized exchanges were a key catalyst for the growth of crypto, they repeatedly displayed the inherent weakness of centralized systems.
Some of the most notable names in this category are Mt. Gox and FTX, two exchanges which lost billions of dollars of customer funds. Events, which led to a crash of the crypto economy with multi-year bear markets as a consequence. These events are just two out of many hundred events where the centralized nature of service providers has failed to protect the interests of its users.
There are hundreds of known incidents from centralized crypto institutions and likely many more we have not heard of yet. Until today, the solvency of exchange can only be speculated about, although proof of reserves is a decade-old topic. A problem we likely will never solve in CeFi.
It’s 2023, and we are still in a post-FTX hangover. As we are slowly coming to our senses, we need to understand the limitations of the status quo and identify where to take action to build a more resilient future.
The centralization created by CeFi, especially large players like Coinbase and Binance, pose a systemic risk to crypto that needs to be addressed.
History is filled with instances of high-profile hacks targeting centralized exchanges. Billions worth of crypto assets can vanish overnight. The centralized nature of these platforms makes them an attractive target, presenting a single point of failure in a space that touts security through decentralization. Billions of dollars worth of crypto assets have been lost since the launch of Bitcoin and the true reserves of exchanges remain uncertain.
A disconcerting note resonates as CeFi exchanges can manipulate the market dynamics, freezing crypto assets in response to market crashes and volatility. The fall of Celsius in 2022 paints a warning of this danger.
The demise of Celsius came when one of its trading schemes backfired, and it began using customer deposits to compensate for its losses. Since there was no reporting mechanism in place, the reserves fell short and a billion-dollar hole emerged, leading to its eventual failure.
Another issue, one which has not been widely enough discussed, is the lack of transparency and the potential for manipulation. An exchange can front run its customers without anyone ever knowing. It’s a subtle but powerful way for exchanges to extract value—trading where the house always wins.
One of the foundational mantras of the crypto community is "not your keys, not your coins." On centralized exchanges, users do not have direct access to their private keys. Instead, they entrust their assets to the exchange, making them dependent on a third party. Centralization often brings with it the power (or obligation) to censor. Some centralized exchanges, owing to regulatory pressures or business decisions, restrict access based on location, creating barriers in a space that’s meant to be borderless. Furthermore, these platforms have the authority to freeze assets or shut down accounts, sometimes without a clear reason.
As centralized entities, these exchanges are more susceptible to regulatory interventions. While regulations are crucial for the safety and growth of the industry, centralized models can sometimes be prone to shutdowns, which can jeopardize users' assets and trust in the system.
A long-running quote in crypto is the following from Mahatma Gandhi:
“First they ignore you, then they laugh at you, then they fight you, then you win.”
As Web3 is gaining importance, the need for governance to attack will increase. We are slowly leaving the stage where the establishment laughs at crypto. A potential scenario is that governments shut down systemically important institutions and seize crypto in custody at scale.
With the launch of Ethereum in 2015, the concept of decentralized application was introduced, which also offered a new approach for finance in crypto, what we call DeFi today.
At its core, DeFi represents a shift from traditional centralized financial systems to protocols and platforms that operate without intermediaries. Using blockchain, particularly smart contracts, and leveraging the principles of decentralization, transparency, and open-source, DeFi offers a vast array of financial services from lending and borrowing to trading and insurance, all without the need for traditional banks or financial institutions.
As we've delved into the issues of CeFi, DeFi emerges as a promising solution to many of these issues:
Permissionless Access: One of the most compelling attributes of DeFi is its openness to all. Irrespective of geography, wealth, or status, anyone with an internet connection can access DeFi platforms and services.
Transparency and Trust: Built on open-source protocols, DeFi platforms allow anyone to review, audit, and verify the underlying code. This transparency fosters trust and encourages a community-driven approach to development and governance.
Censorship Resistance: Without central control, DeFi platforms are inherently resistant to censorship and external interference, be it from governments, institutions, or any other entities.
No Single Points of Failure: The decentralized nature of DeFi protocols distributes the network's operational load across a myriad of nodes. This not only enhances security by reducing risks associated with centralized targets but also ensures resilience against systemic failures.
True Ownership of Assets: Decentralized protocols champion the principle of self-sovereignty. Users maintain control of their private keys and, by extension, their funds. This stands in stark contrast to the CeFi model where funds are held by the exchange, presenting a risk of loss due to hacks or malfeasance.
Open and Transparent Governance: DeFi operates on transparent and often community-driven governance models. Decision-making isn’t confined to a centralized entity; instead, it’s typically based on consensus mechanisms that involve the broader user community, fostering trust and reducing the potential for behind-the-scenes manipulation.
Regulatory Arbitrage: While it's not entirely immune to regulatory measures, the decentralized nature of DeFi offers a degree of resistance. Decentralized protocols are not tied to specific jurisdictions and, thus, can be more flexible and adaptable in the face of regulatory changes.
Global Accessibility: Unlike centralized platforms, which might impose geographical restrictions, DeFi protocols are truly global. They do not discriminate based on location, offering truly borderless financial services.
Interoperability and Composability: DeFi projects are often likened to "money legos." They can be stacked, combined, and interconnected. This composability means projects can build upon each other’s offerings, leading to a synergistic and interconnected ecosystem that maximizes user benefits.
Until today, DeFi has proliferated a number of protocols, such as DEXs and lending protocols to name a few. The 1delta protocol is novel but stands on the shoulders of giants and integrates leading liquidity protocols to compose a high-performance trading protocol that offers the best rates from the market and is competitive with an increasing number of centralized exchanges, offers advanced features such a margin trading and leverage to enable CeFi-like experience, and is openly accessible to anyone with the goal to replaces centralized exchanges and brokers.
As a decentralized protocol, our goal falls into the broader mission of Web3 and DeFi, which is to democratize access to financial services.
But in particular, we made it at 1delta our mission to accelerate the transition to DeFi and foster a robust decentralized economy. That’s why we are developing the 1delta protocol, to replace CeFi providing a solution that can power all sorts of crypto trading applications with a decentralized backend.
1delta is not just a protocol; it’s a movement. We welcome anyone to join us on our mission– community members, crypto institutions, exchanges, and even our competitors – to come together and build a strong financial backbone for Web3.