The recent events in the digital assets industry have left an adverse impact on the sentiment and morale of users and investors. The primary reason behind the fiasco that we saw in the last few weeks was the lack of transparency from centralised exchanges or CEXs.
These organisations in question can be classified as CeFi products as even though they position themselves as Web3 enterprises, they operate in a centralised manner with certain custody and control of user funds. There is little to zero visibility on their corporate structuring, governance and decision making processes.
The aftermath led many industry participants to ask CEXs to provide a proof-of-reserve of their funds to mitigate similar scenarios in the future. Since then, few exchanges have published a list of their wallets and assets to regain customer confidence. However, we are yet to see an industry standard on how to make the proof-of-reserve more transparent, consistent and trustworthy across the board.
An arguably better approach for retail users affected would be for them to go back to the first principles of blockchain technology – to have custody of their own assets and have a trustless mechanism to verify assets, transactions and interactions on chain. The outcome that CEXs are trying to achieve with publishing proofs can be done in DeFi (decentralised finance) in a simple way with the help of tools like chain explorers and having open source code.
The industry is still in a nascent stage where undesirable events like these can make a dent in the short-term and slow the pace of adoption. The way forward is to understand the long-term promise of the technology along with managing risks properly. This means diversifying assets across platforms, doing our own research before using or investing, and not making decisions that are only focused on short-term gains in an unsustainable or high-risk manner. That said, every person is different and each of us has different goals and objectives, so we should all be mindful of our decisions and look for the relevant help and advice when necessary.
Since the fall of Luna, 3AC (Three Arrows Capital) and later bankruptcy of many major centralised lending platforms, what stood out was how instead some of the decentralised lending and borrowing platforms, decentralised exchanges and other DeFi protocols performed business as usual.
The debt that the CeFi platforms owed to DeFi protocols had to be returned first, because DeFi products that were governed by smart-contracts functioned as intended and would have liquidated the positions if the margin calls were not answered.
After the downfall of FTX, many players in the crypto industry have come forward in favour of decentralisation – not just as a narrative, but a necessity for long-term success of Web3. Most of the prominent leaders in the space, from Brian Armstrong at Coinbase to Sandeep Nailwal at Polygon, all highlighted the need for building better systems with DeFi and self-custodial wallets that don’t rely on trusting third parties or unregulated intermediaries.
DeFi products are often structured to be run as decentralised autonomous organisations that are governed by the community. The community has full visibility on the operational processes and functioning. They can contribute democratically in defining the product vision and call out any concerns more openly to the broader audience.
This is a completely user-led movement, enabled by blockchain technology, which supports in designing better digital products that are more inclusive. The recent events have highlighted that the Web3 technology enabled by new token mechanisms and incentive structures has the potential to disrupt many traditional financial entities. This is where decentralised finance or DeFi comes in and improves the auditability and accountability by how DEXs and DeFi protocols manage their locked capital and treasury with publicly available smart-contracts.
The DeFi innovations are making the product experiences comparable to (if not better than) centralised solutions. With increased scalability, reduced transaction costs, improved liquidity and easy on-boarding – DeFi products are at par with their centralised peers in addressing customer needs and ripe for building the future of finance that is more secure, efficient and robust.
The author is India Lead, dYdX Foundation
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