Utility Over Decentralized Finance: DeFi vs. CeFi

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By Alex Mashinsky When the Industrial Revolution began, the gold standard was in place to help remove the risks of currency fluctuations from international trade and prevent governments from printing money and inducing inflation — the same type of fiat inflation we are seeing now, almost 100 years later. As […]

By Alex Mashinsky

When the Industrial Revolution began, the gold standard was in place to help remove the risks of currency fluctuations from international trade and prevent governments from printing money and inducing inflation — the same type of fiat inflation we are seeing now, almost 100 years later. As the Fed continues to print money as the solution to every problem, we only had a few times in the last 50 years where we earned more than we borrowed. Decentralized Finance (DeFi) projects can use this history to guide them in solving issues that have plagued the financial industry since we went off the gold standard in 1971. To do this, they need to assess the risks of propagating the financial services conveniently offered to us by Wall Street, and look to merge the benefits of DeFi + CeFi (centralized finance) utility to deliver financial freedom to 7.5B people living on this planet. 

DeFi and CeFi have the chance to side with the depositor, to create utility that always acts in the best interests of the people, creating sustainable long-term value with the users depositing the assets instead of maximizing profits for financial middlemen.

Many DeFi projects have been introducing financial services that seem to have great potential for providing users with equal benefit for borrowing and lending, including high-yield interest income and low interest loans. But things like DeFi fractional reserve lending and DeFi yield farming run the very real risk of working against the retail consumer. With yield farming, leveraging DeFi protocols to generate high rates of return has novice users piling into high-risk situations through surges of liquidity combined with unstable protocols. There is a major downside for retail users when the DeFi farming bubble pops as it does not provide sustainable income or creates true economic value in the process. 

The recent example of YAM dropping over 99% in a few hours or the 5x discrepancy between DAI in circulation and what’s reported as held on Compound are all prime examples of avoidable mistakes from promising projects. Utilizing early adopters from the “fomo” created by others looking for quick wins. 

During the coronavirus pandemic, the U.S. got rid of its 10% reserve banking requirements, quietly going from already risky 10% fractional reserve to a zero reserve, and the same risks exist for new DeFi projects touting fractional reserve loans. Neither system is working in favor of the customers who continue to deposit their life savings with banks and DeFi not knowing the risks involved. 

DeFi, at its core, holds the promise to allow the people more freedom and less fees over their assets and financial decisions. When DeFi copies fragile banking methods for short-term benefits, they risk putting unsustainable income and newly created financial protocols over the goal of providing the most stable utility and income to users. Better education for new users on what safety through DeFi looks like is an important step to truly reduce and replace the toll collectors and middlemen in financial services.

While Banks have the FDIC, DeFi and CeFi need to set up a similar safety net which will protect depositors against hacks or fraud and allow this nascent industry a chance to grow and replace the failing fractional reserve system.

We cannot discount the tremendous growth and attention these projects have brought to the DeFi space and the importance of having over $4.48B in value-locked (a $3 billion increase since May much of which is double or triple counted via farming). However, the interest in DeFi creates the opportunity not to be a neutral service provider. Instead, DeFi should build out new financial services that address the riskiest financial practices we all have to live with today and replace them with better solutions that create positive benefits for the people depositing their life savings.

DeFi will start complementing CeFi when it begins to build real bridges to the centralized financial world to bring in more fiat and assets from new users in all countries. Instead of seeing these as competing segments of financial services, we need to consider how we can utilize DeFi to create sustainable long term value in the three most essential buckets for adoptions: crypto assets, tokenized gold, and stablecoins. There are two ways that DeFi can start achieving real utility, rather than competing against itself with who will do a bigger airdrop or invent the best protocol. 

  1. DeFi Projects need more customer centric balance between financial utility and decentralized protocol by fixing the fundamental problems of traditional finance, DeFi has to find ways to make investors feel safe onboarding into these assets. A great example is the projects looking for yield and value creation through an evolution from MPC technology to sMPC that can create a more robust entry-point through cross-chain liquidity. Helpful in tackling the issues of creating more, new fractional reserve banking like models on single chains.

  2. Not ignoring the benefits of centralized finance is another crucial step here. CeFi solutions can provide a positive balance between retail and institutional focus that is better than the arguments for open protocols (when discussing the mainstream adoption of DeFi). CeFi can provide things like company-wide financial audits of the treasury and create a familiar and user-friendly framework without imposing the same kind of risky systems that work against the retail users.

Ultimately, there is considerable upside to the DeFi space, and 2020 has shown not only demand but a need for this technology to continue to grow and evolve. Like it or not, it has to get to a less risky place for mainstream adoption, because right now when the water recedes, as it did on March 12 with Black Thursday, you see which projects have been swimming naked; liquidating most of their customers when a flash crash happens. 

I believe that CeFi can offer DeFi lessons in utility over protocol with semi-centralized solutions to help create stable fintech solutions and keep rates paid to users higher, volatility lower, and onboard many more institutions that may not be comfortable with the space today. Only then can DeFi really offer greater financial freedom to the world that it is promising. DeFi projects should carry the flag for doing financially well only after they can do good for the crypto community. 

Alex Mashinsky is one of the inventors of VOIP (Voice Over Internet Protocol) with a foundational patent dating back to 1994 and is now working on MOIP (Money Over Internet Protocol) technology. Over 35 patents have been issued to Alex, relating to exchanges, VOIP protocols, messaging and communication. As a serial entrepreneur and founder of seven New York City-based startups, Alex has raised more than $1 billion and exited over $3 billion. Alex founded two of New York City’s top 10 venture-backed exits since 2000: one of his first companies, Arbinet, IPO’d in 2004 with a market capitalization of over $750 million; and another venture, Transit Wireless, was valued at $1.2 billion at the time of exit. Alex has received numerous awards for innovation, including being nominated twice by E&Y as entrepreneur of the year in 2002 & 2011; Crain’s 2010 Top Entrepreneur; the prestigious 2000 Albert Einstein Technology medal; and the Technology Foresight Award for Innovation (presented in Geneva at Telecom 99). As one of the pioneers of web-based exchanges, Alex authored patents that cover aspects of the Smart Grid, ad exchanges, Twitter, Skype, App Store, Netflix streaming concept and many other popular web companies. Additionally, Arbinet’s fundraising story was featured as a case study in 2001 by Harvard Business School.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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