Have you ever staked tokens on a major crypto exchange like Binance or Coinbase? If so, you are familiar with Centralized Finance (CeFi) – the technology that is transferring the traditional financial system to blockchain.
With CeFi, one could easily borrow the necessary tokens at a predictable interest rate, benefit not only from increasing the value of your portfolio, but also from locking up one’s assets to earn stable interest – not to mention the easy access to the financial system that so badly needed is underserved areas of developing countries. As such, it should come as no surprise that CeFi has been widely hailed as a robust and relatively risk-free investment opportunity that offers an easy entry point into the blockchain financial markets.
Well, that is no longer the case. The recent bearish market and black swan events like the collapse of Terra have revealed a massive problem: CeFi, which is supposedly risk-free, has major problems with risk management. Three Arrows Capital, Celsius, Voyager Digital, Vauld—this isn’t even an exhaustive list of crypto-institutional CeFi funds that have filed for bankruptcy.
So what are the alternatives to CeFi? Why is DeFi not a panacea when it comes to risk management and how can we combine the advantages of both concepts to achieve more sustainable wealth creation?
CeFi in Crypto: More Than Just Retail Business, So Dangerous
You deposit money at a commercial bank at, for example, 5%. A bank lends this money at 7%. This 2% discrepancy – the spread – is the blood flow of traditional retail banking given its predictable risk profile and stable returns. In particular, this strategy is intuitive to investors who can be reasonably confident that their money will be returned.
However, there are significant downsides to retail crypto banking, such as: B. a limited return on investment (ROI) and scalability. While cryptocurrency adoption rates are indeed skyrocketing, they are drastically lagging behind those of traditional finance. As such, there is a low profit cap for CeFi companies and a strong incentive to switch to riskier alternatives.
The crypto industry is still nascent and the lack of developed regulations creates a high level of opacity: once locked, your funds are in full control of the custodian and you never know what the risk is and whether the strategy is adequately hedged .
DeFi and Sophisticated High Yield Strategies
To continue the banking analogy, DeFi is to CeFi what structured finance is to retail banking — in other words, a spectrum of sophisticated high-yield instruments with extreme variability. A clever combination of different decentralized financing options results in strategies tailored to an investor’s specific needs, including desired volatility, expected return and risk exposure. Additionally, DeFi algorithms are transparent as they are based on smart contracts, so there is no custody or fraud risk.
However, this does not mean that risk management in DeFi is more accessible. Taming complicated derivatives and techniques takes time and expertise, and there are numerous technology-specific risks. For example, protocol vulnerabilities sometimes elude even the most cumbersome technical audit, which is why you often hear about DeFi hacks and exploits. At the same time, the economic incentives can also be misjudged, leading to unpredictable and dangerous user behavior.
CeDeFi, a perfect symbiosis
What if DeFi became more accessible and straightforward? What if, instead of manually combining complex instruments, rebalancing your portfolio, analyzing protocol reliability and calculating risk, you had access to the best strategies prepared for you by experts? This is Centralized DeFi (CeDeFi): the future of crypto finance that combines the best of both worlds: the ease of access and understanding of CeFi with the transparency and high returns of DeFi.
With these finely tuned strategies, one could benefit from both yield farming and appreciation, while using derivatives to hedge against a negative outcome, and thus outperform regardless of market conditions. Also, they could benefit from algorithmic trading, volatility prediction and arbitrage, or use token farming. Most importantly, regardless of the strategy chosen, a user gets full visibility into where and why their funds are going, the likely risks and how they are hedged, the expected rate of return – all with no locks.
The demand for flexible and robust strategies is increasing sharply in the conditions of volatile crypto markets. A good example of this are the three new CeDeFi strategies launched by Midas in mid-August: «Soft Long» and «Soft Short» on ETH and «DeFi Token Farming». Targeting different market conditions, they attracted more than $1.5 million in user deposits in the first 12 hours and are expected to add $20 million to the platform’s assets under management next month. The strategies show a high level of performance: for one, the LPs of the DeFi token farming strategy increased by more than 75%. These figures demonstrate the increased interest of CeFi users in CeDeFi solutions.
Conclusion
In summary, centralized finance is becoming obsolete: retail banking generates low returns, while alternative strategies are opaque and risky. DeFi, on the other hand, offers algorithmic efficiency and instrument variability – but is notoriously elusive and comes with its own set of risks.
Providing lucrative DeFi opportunities in a convenient CeFi shell is a logical evolutionary step for the industry. Add to this better risk management, sustainable wealth creation and ease of use, and we can see the CeDeFi not only as a practical investment option, but as a new opportunity to drive adoption and integration into the global financial system.
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