By Korapat Arunanondchai, EvryNet
2020 was undoubtedly the year of DeFi, bursting onto the scene during DeFi Summer in July of that year. According to Dappradar’s 2020 report, “dapp transaction volumes surpassed $270 billion, with 95% accounted for by Ethereum’s DeFi ecosystem.” Decentralized finance protocols ushered in a transparent, trustless financial revolution across multiple fronts - ranging from lending and borrowing, derivatives, insurance, stablecoins, DAOs, and decentralized exchanges. With currently over $250 billion of value locked in the DeFi ecosystem, it’s clear that the industry has staying power. Despite how DeFi’s inherently decentralized nature runs counter to its centralized counterparts, that hasn’t stopped traditional finance institutions from trying to find a way to tap into the burgeoning DeFi ecosystem.
That’s where CeDeFi, short for centralized decentralized finance, comes in. The CeDeFi term was initially coined by the CEO of Binance, Changpeng "CZ" Zhao, when Binance launched its Binance Smart Chain in September 2020. Their BSC chain set out to bridge the gap between centralized and decentralized finance, kicking off a $100 million USD seed fund designed to foster collaboration between CeFi and DeFi. Users can stake Binance’s native token, BNB, and earn farmed tokens of other upcoming projects promoted by Binance. This allows users to earn some of the benefits of being exposed to DeFi, without the burden of interacting directly with DeFi protocols. Since then, other chains have been exploring ways to architect their networks to retain the best of DeFi while ensuring accessibility for centralized parties.
Let’s look ahead at some of the remaining hurdles between CeFi and DeFi, as well as some of the main benefits that CeFi can lend to the overall DeFi space.
Remaining Hurdles
There are two primary barriers to centralized adoption of DeFi: security measures and CeFi-scale liquidity.
First, the lack of industry-wide security measures is keeping billions of dollars sitting on the sidelines in centralized finance markets, waiting to get plugged into the larger DeFi ecosystem.
According to a report from London-based firm Eliptic, the overall losses caused by DeFi exploits have surpassed $12 billion in 2021 alone. Beyond the staggering financial losses, the constant headline-grabbing hacks make for easy fodder for regulatory agencies and governments looking to discredit the industry as nothing more than a “Wild West'' casino. Beefing up industry-wide security is a must for wider institutional adoption of DeFi to take place.
Second, there are liquidity issues to overcome. DeFi lacks an institutional-ready DEX, as current DEXs lack the depth of liquidity needed to truly support major CeFi players. Uniswap, the largest decentralized crypto exchange, currently facilitates roughly $1.7 billion in daily volume across its V2 and V3 platforms. For comparison’s sake, NASDAQ sees anywhere between $300-400 billion in daily volume, while centralized cryptocurrency exchanges like Binance see around $21 billion in daily volume. DEXs automate the settlement and market-making processes via smart contracts, in stark contrast to their centralized counterparts which tend to operate in a black box. While centralized crypto exchanges such as Coinbase offer compliant custodial services targeted at institutions, the industry still lacks a decentralized exchange that can serve as a safe and trusted bridge between CeFi and DeFi. A stable, secure and compliant DEX that can support the demands of the broader institutional needs will be a game-changer for crypto.
Benefits to letting CeFi into the DeFi landscape
One of the main benefits institutions have is their inherent connections to governments and regulatory agencies, which can help expedite the global adoption process for DeFi as a whole. If we embrace certain elements of long-standing CeFi businesses, this can help solve the lingering regulatory issues that have kept larger institutions on the sidelines. Antoni Tenchev, the co-founder of Nexo, wrote a thought-provoking op-ed on how CeFi can serve as a bridge between DeFi and regulation, and I agree wholeheartedly with his take on the matter:
While DeFi presents new regulatory challenges, there are ways to ease this burden initially. Centralized finance (CeFi) companies can be the interim solution, serving as a bridge between the traditional financial sector and the regulatory framework that encapsulates them on one hand and the decentralized finance space on the other. These companies very well understand the sector from both the infrastructure point of view and the needs of their users.
Clear regulation will be a boon for the industry as a whole, and it makes sense for some DeFi projects to essentially piggyback off of existing CeFi infrastructure (including existing KYC/AML procedures).
Another significant benefit for integrating with CeFi is that, to put it simply, it would help DeFi scale its infrastructure. While DeFi currently has roughly $250 billion in total value locked (TVL), CeFi is much more accustomed to handling trillions - the global equity market cap is estimated to be over $100 trillion, a staggering amount greater than DeFi. I agree with James Taylor of Coindesk here - “DeFi is revolutionary in terms of tech, but CeFi is undoubtedly more experienced in responding to market and governmental pressures.” While a massive gap in TVL and total market caps currently exist between DeFi and CeFi, I see this as an exciting indicator of how much more room for growth and maturity there is in the DeFi space in the coming years.
I’m highly confident that the CeDeFi space will continue to grow and be a mutually beneficial, symbiotic relationship. One where CeFi players get to tap into the countless technological breakthroughs offered by DeFi’s transparent ecosystem of dapps, and where DeFi can glean invaluable insights from its more mature, regulatory hardened CeFi counterparts.
Korapat Arunanondchai co-founded an e-commerce travel startup before going on to do his MBA at Georgetown University. He has experience working in Venture Capital firms in Thailand with Inspire Ventures and K2 Venture Capital and in SF with Creative Ventures.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.