The Problem With CeFi Exchanges & Why We Need DeFi Now More Than Ever

The collapse of FTX and Alameda has given anti-Web3 communities fresh ammo over the past couple of weeks. Many are framing FTX’s failure as a failure of the entire DeFi mission, instead of seeing how CeFi values are at the root of the debacle.

Let’s take a closer look at what happened, and why this strengthens the case for decentralized finance.

FTX Crash Explained

Earlier this fine November, one of the world’s largest crypto exchanges crashed. Sam Bankman-Fried, the founder of FTX, was said to be making the world crypto accessible and acceptable to the mainstream. That is until it was uncovered that FTX was shifting customer assets to Alameda research (a quantitative trading firm also operated by Bankman-Fried). They were then used to fund risky trades and bail out the firm when necessary.

Binance, FTX’s competitor, sold off its FTX tokens left over from a 2021 deal with Bankman-Fried, sparking concerns about the company’s stability. This led to a drop in the price of FTX tokens and massive customer withdrawals from the exchange.

The end results (so far)?

1. FTX filed for bankruptcy.
2. Bankman-Fried resigned.
3. Ordinary people lost a lot of money.
4. Lots of people were left shaking their heads and saying, “I told you so” about the shadiness of crypto and decentralized finance.

Don’t Blame DeFi

Here’s the problem with point #4: The issues that led to FTX’s collapse had nothing to do with DeFi. These are all issues that are addressed, if not resolved, by the core values of decentralized finance.

On DeFi platforms, like an exchange, individual deposits do not exist. Instead, users make trades in liquidity pools managed by smart contracts. In other words, the protocol founders/team can’t pull off any shady business with user funds. Unlike FTX, DeFi exchanges can’t lend out customer deposits– it’s written in the code.

On lending protocols like Aave or Compound, to take out a loan you first deposit enough to cover the loan value. If this is no longer the case– either because collateral value decreases or the value of the asset borrowed increases– the loan is automatically liquidated. FTX, on the other hand, gave out bad loans to Alameda, which were then used as collateral on other loans. The DeFi lending model prevents this doomed model.

People have been quick to call DeFi sketchy, but they forget that much of what happened with FTX wouldn’t be possible on a DeFi platform, where the blockchain records every transaction.

DeFi Use Cases to Explore

With this in mind, now is a good time to explore the many transparent and lucrative use cases for decentralized finance.

Decentralized Exchange

On a centralized exchange, all of the users' funds are stored in a central location, making them vulnerable to hacks. In contrast, on a decentralized exchange, each user stores their funds, and the exchange does not have access to those funds. This makes it much more difficult for hackers to steal user funds.

In addition, decentralized exchanges are often more private than centralized exchanges, as they do not require users to provide personal information.

Lending

DeFi lending platforms allow users to collateralize their crypto assets to take out loans. Lenders can then choose which loans they would like to invest in, and they can do so with the peace of mind that their investment is backed by collateral. As a result, lending platforms are making it easier than ever for people to access the capital they need to grow their businesses or make trades.

Plus, DeFi offers unique takes on the traditional lender-borrower relationship. Take, for example, Sturdy: the first positive-sum protocol, providing interest-free borrowing and high-yield lending. Sturdy stakes deposited collateral into third-party protocols like Lido. Staking yield is harvested and distributed to stablecoin lenders, thus providing users with real yield. This model cuts out the utilization rate model, which pits borrowers and lenders against each other, and includes high fees which push users back to CeFi.

dApps

dApps are decentralized applications that run on a blockchain. Unlike traditional apps, which are controlled by a central authority, dApps are distributed across a network of computers, each verifying and executing transactions. This decentralized structure has many advantages, including improved security and resilience to attacks. Furthermore, dApps are often designed to be censorship-resistant, so they can't be shut down by a single entity.

dApps also provides users with a fun and easy way to get involved in the world of cryptocurrency; for example, CryptoKitties is a popular blockchain game where users can buy, collect, breed, and sell virtual cats.

From decentralized exchanges to lending protocols, dApps, and beyond, DeFi applications are changing the way we think about secure and lucrative financial models. While it’s easy to blame DeFi for events like the FTX crash, a closer look underscores that DeFi is not the problem but the solution.