CeDeFi: The Crypto Ecosystem's Swiss Army Knife
As the excitement around trustless protocols and high-yielding decentralised finance (DeFi) products swept through the crypto community, investors eagerly embraced the possibility of a revolutionary upheaval in traditional finance.
DeFi’s rapid expansion has attracted billions of dollars in investments thanks to its wide range of innovative financial products. However, the fast-paced expansion of DeFi has also brought its fair share of risk. The lack of proper security measures and vulnerabilities in smart contracts has only exacerbated these issues, leaving DeFi exposed to the ever-present threat of hackers and scams, who have stolen a record of over USD 3 billion from exchanges and DeFi protocols in 2022 alone[1]. Now, the current bear market has only added to investors’ woes, as they struggle to navigate the rocky landscape of DeFi.
But centralised finance (CeFi) is not the answer
While DeFi has its own set of challenges, CeFi is far from perfect. The lack of transparency in CeFi entities has led to many issues of bad practices and abuse that have cost investors billions of dollars. Even worse, these companies often operate under a veil of secrecy, only revealing their true nature after the damage has been done.
Both CeFi and DeFi entities have their flaws, so it is important to consider how we can harvest the most valuable components from both systems. By analysing their strengths and weaknesses, we may be able to create a financial system that is both transparent and secure, offering investors (and companies) the best of both worlds.
Put two and two together
Centralised decentralised finance (CeDeFi) is a new approach to leveraging the power of DeFi technology with the governance structure of CeFi. CeDeFi platforms provide a centralised interface for accessing and managing DeFi protocols, making it easier for users to take advantage of the benefits of DeFi without having to navigate the complexity of its underlying protocols.
CeDeFi platforms offer access to DeFi products, such as lending, staking, yield farming and decentralised exchanges (DEX), to name a few. Here are 5 key characteristics that a CeDeFi platform might have:
Hybrid structure: They have a hybrid structure, with some elements of the platform being centralised and others being decentralised. For instance, the platform might have a centralised order matching system, but use decentralised smart contracts to facilitate trades and manage funds transparently
Interoperability: They are designed to be interoperable, allowing users to easily move assets between the platform and other financial systems, like traditional banks, crypto lenders or decentralised exchanges (DEX)
Improved accessibility: They aim to make it easier for users to access crypto and financial services, by providing a user-friendly interface and simplifying complex financial processes
Enhanced security: They prioritise security and aim to protect users’ assets and information from unauthorised access or tampering. This could be achieved through a variety of measures, such as using secure encryption protocols and implementing robust risk management systems
Increased efficiency: They aim to increase efficiency by streamlining financial processes and reducing the time and cost associated with conducting financial transactions using blockchain and smart contracts
For instance, traders can use CeDeFi platforms to filter out the best options for trading fees, liquidity needs, and KYC conditions, whereas institutions can gain access to innovative DeFi products while still following traditional financial rules and regulations.
Managing the risks of DeFi – a necessary trade-off?
As DeFi continues to disrupt traditional financial systems, CeDeFi platforms are emerging as a new breed of financial intermediaries. On one hand, they provide users with access to innovative and borderless financial instruments, like stablecoins and DEXs. On the other hand, they also offer the control, regulatory compliance, and investor protection measures that are often lacking in pure DeFi systems.
That said, in jurisdictions where cryptocurrency is legally recognised, CeDeFi providers are obligated to protect their customers’ funds as mandated by the law. If something goes wrong, such as a hack or market collapse, CeDeFi platforms would be legally liable[2]. This added level of protection can be especially reassuring for investors who are wary of the inherent risks associated with DeFi.
Moreover, because CeDeFi platforms depend on the health and stability of these protocols, they are highly selective about which ones they choose to integrate with. This ensures that only the best and most reliable protocols are being used which minimises risk exposure and helps prevent users from scams. This makes CeDeFi platforms a trusted and secure choice for participating in the crypto ecosystem. Here's how they compare:
*This comparison table refers specifically to regulated CeFi platforms (operate under the oversight of regulatory authorities). Unregulated CeFi platforms, like certain cryptocurrency exchanges and lending platforms, may not have the same level security, compliance or KYC requirements. They are also subject to additional risks, like fraud or loss of assets due to hacks or other security breaches.
Moving forward cooperatively
As the DeFi space continues to evolve, it is important to ensure that smart contracts are thoroughly audited and secure[3]. This is especially the case for things like cross-chain bridges, where connecting two networks with large sums of funds hinge on just a few lines of code. This means vigorously testing for errors, bugs and vulnerabilities from the source code itself. Encouragingly, there are steps that can be taken to mitigate these risks.
Collaboration between DeFi stakeholders and third parties (like auditing firms) will be essential for building a secure and stable CeDeFi-based ecosystem. By pooling their knowledge and resources together, the industry can provide the necessary guidelines and expertise needed to create reliable code, reducing the risk of vulnerabilities and hacks.
As DeFi is still in its early stages, every chance to improve its underlying technology is valuable in helping its ecosystem flourish and become more robust. This will also be key to building a solid foundation of security and stability for the broader crypto ecosystem.
Working towards a strong and stable future
With its decentralised and open approach, DeFi is disrupting traditional financial systems, offering a range of benefits such as transparency, accessibility, and efficiency. However, DeFi also has its own set of challenges, including security vulnerabilities, liquidity risks and a steep learning curve for many users.
CeDeFi brings together the best of both worlds, offering the efficiency and transparency of DeFi and the usability of CeFi, all while operating within the framework of existing laws and regulations. Sure, they may sacrifice some degrees of decentralisation in the process, but the trade-off is worth it for the peace of mind and convenience they bring.
As recent events such as the FTX collapse, DeFi hacks, and other adversities throughout 2022 have shown, it is clear that CeFi and DeFi have a role to play in the world of crypto. But by embracing CeDeFi, we can create a system that is both realistic and productive for the future, recognising the value of heritage while also adapting to the changing times and harnessing the power of crypto innovation and blockchain technology.
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[1] 3 billion stolen in crypto heists here are the eight biggest, Forbes, December 28, 2022.
[2] When trust dies mistrust blossoms: is proof of reserves a step towards rebuilding industry trust?, Sygnum Bank, December 21, 2022.
[3] CeFi vs. DeFi: Everything you need to know, Beincrypto, November 22, 2022.
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