Financial institutions are beginning to realize the need to embrace decentralized finance (DeFi) all the time. By the end of 2023 the largest DeFi ecosystems will be the most transparently decentralized.
Although decentralization is the foundation upon which all blockchain technologies are built, it is not guaranteed across crypto. The recent boom-bust market cycle has been marked by the rise of two competing approaches to crypto financial ventures: anti-censorship and momentum.
Kevin Mehrabi is the CEO of WealthChain. This article is part one Crypto 2023.
In recent years, the few financial institutions that have ventured into crypto have typically preferred to invest in centralized companies. These are companies that provide transparency and are run by reputable people.
In 2023, we will finally see a massive shift in their corporate interest towards true trustless protocols after the disastrous reckoning in the crypto industry.
The decentralization-first crowd is launching their platforms at the smart-contract level – using permissionless applications on the blockchain. Although protocols such as Compound, Aave and Uniswap have development companies, they are primarily protocols. By ensuring that the flow of funds is visible in a public block ledger, they avoid custodial wallets and off-chain collateral.
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Centralized efforts are often misconceived in traditional finance. Of course, layer centralization across blockchains can lead to the same problems that inspired Satoshi Nakamoto to create Bitcoin. DeFi is the completion of this decentralization-first pure approach in its truest sense.
Centralization-first entrepreneurs have historically paid lip service to crypto’s core principles of openness, verifiability and irreversibility. They dismissed the decentralization-first approach as unsustainable idealism from a tone-deaf technocrat. And, true enough, FTX, Celsius Network, Nexo, BlockFi and Voyager Digital scaled quickly. But high speed and high feature capacity come with risks.
The events of 2022 proved that centralization-first approaches to crypto finance present high risk. In fact, the unmonitored control of off-chain capital by FTX and Celsius enabled the wrongdoings and bad trades that led to their catastrophic collapse. Meanwhile, the transparency and security of a decentralization-first set including Aave, Compound, Sushi and dYdX have left those DeFi platforms virtually unscathed. truly, Uniswap recently outperformed Coinbase For the first time it became the second largest exchange in the world by trading volume.
Critics will point to history DeFi Hacks Proof that DeFi is not as secure as decentralization-first purists describe it. However, those exploits do not represent the whole. Instead, many exploits this year were due to the rush of untested sites released into the wild and by security auditors. Demand is high This was more than their ability to maintain standards. When built, reviewed, and managed properly, DeFi platforms are as secure as the blockchains they are deployed on.
Likewise, in 2023, the degree of decentralization among the underlying blockchains will increase in importance for DeFi. Poor decentralized blockchain governance has led to controversial hard forks for the blockchain community, the network, and most importantly, every digital asset published. That chain “splits”.
Without decentralized governance, disagreements can lead to secession. The consequences of these events are unpredictable: each faction claims to be a true continuation of the previously linked chain. A faction can amass a network and gain dominance—but that dominance May change over time. Uncertainty is the problem.
Asset-splitting risk is an under-discussed problem for DeFi – with potentially disastrous consequences. Ethereum underwent a controversial chain split after its latest hard fork (The Merge). JP Morgan expressed concern A competing proof of work for Ethereum could cause market confusion and fragment the network. That didn’t happen this time, but that’s because almost everyone building on Ethereum supported the upgrade to proof-of-stake — not every decision is black and white going forward.
See also: Where is the Ethereum Virtual Machine Heading in 2023? (Hint: Beyond Ethereum)
If Tether’s USDT holdings suddenly had to pledge assets to not only one set of tokens in Ethereum, but two after the controversial chain split. For financial institutions that value the prospect of tokenizing trillions of dollars in capital and quadrillion dollars in derivatives, even the slimmest possibility of asset separation becomes unacceptable.
So, how can financial institutions embrace DeFi while minimizing asset-splitting risk? A simple solution is through diversification into different DeFi ecosystems. After all, “the future is many chains”. An additional safeguard is to engage with DeFi ecosystems on blockchains that are less prone to asset splits – that is, blockchains with more decentralized forms of governance.
How can blockchain decentralize ethical governance? Blockchains like Algorand enable moderators to vote on upgrade proposals. I have been instrumental in seeing Tesos, a network, succeed, chaining many management decisions. So far, Tezos has received 12 successful upgrades since its launch in 2018.
As financial institutions increasingly engage in DeFi in 2023, the scope of standards for decentralization will extend to governance at all levels. This should take DeFi platforms and blockchain communities into consideration.
The views and opinions expressed herein are those of the author and those of Nasdaq, Inc.