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DeFi: too much suffer from centralization, what can be done?

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Decentralized finance (DeFi) is not excluded from the tough time that much of the crypto sector is experiencing. Since December, its total value has been locked in fallen, which is by 70% per DefiLlama data. Mind you, it’s not only this but also how different platforms that fall within the space of no-decentralized DeFi are under threat of collapse – the latest is the Celsius’ suspension of withdrawals and the manifestation of the ongoing crisis.

While Celsius is nominally made decentralized by its inclusion within the Decentralized Finance sub-sector, its control over users’ funds shows how too centralized it is. As for Terra’s collapse, serious questions have been raised if DeFi must be fully decentralized, and even if it can be. There is a mixed opinion here as the figures of some industries affirm that centralization offers several benefits over decentralized platforms. Also, there is agreement that only decentralization is almost not a guarantee against future crashes and collapses.

Is too much DeFi not decentralized?

The industry’s figures are less or more in agreement that current events that involve several platforms (including Celsius) emphasize the level at which centralization is uncomfortable within DeFi.

The Co-founder of DeFi protocol Swarm, Timo Lehes, explained that the recent events about Celsius, Lido, and Three Arrows Capital indicate that an issue is posed by a lack of decentralization to DeFi.  He showed that one of the challenges that DeFi faces is that the occurrence of decentralization is on a sliding scale, featuring platforms composed of centralized and decentralized elements.

Lehes told that there are benefits for institutions and individuals in the deployment and architecture of DeFi innovation, such as transparency and self-custody, irrespective of the centralization of other parts of a service. Nonetheless, a centralization issue and transparency concern  are recent challenges from major lending platforms

Looking at Celsius specifically, you will see that the platform mixes centralized and decentralized elements. Nonetheless, it can be argued that it’s precisely centralized in the most critical parts.

A crypto-economist at trading platformTrakx –Ryan Shea– showed that the ledger of infrastructure and smart contracts of DeFi are used. Still, client funds are summed up in custodial wallets (controlled by the company).

Here Shea considered centralization or decentralization a binary issue, which means that centralization in only a crucial area is ideal to centralized a platform.

He told that no matter what decentralized features are deployed by their business model, it is centralized if any of its parts incorporate centralization. So numerous prominent lenders also deploy centralized structures like transactions and hot wallets.

There is a need for a DeFi platform or company to operate on a less or more fully peer-to-peer basis if it intends to be decentralized. Every executed transaction using smart contracts will have to run on a distributed network of PCs.

Shea further explained that the leading company may not be trusted by Centralized Finance (CeFi) but trust the integrity of the code in charge of the smart contracts.

Others support are for the fact that no DeFi platform is decentralized if there’s centralized control of user funds, irrespective of any operations carried out on a distributed basis.

The Co-founder of decentralized computational network Flux, Dan Keller, showed that most Defi platforms are not decentralized in reality but only in name. And the solution is that industry participants should push for better decentralization for better products.

Yes, centralization can birth some challenges for DeFi platforms and crypto, even with the decentralization of transfers and funds.

Timo Lehes affirmed that Lido, for example, could become susceptible to more attacks if too many nodes in it are operated on Amazon Web Services, affecting the essence of governance and distributed network infrastructure.

What can DeFi do to become more decentralized?

According to Lehes, there is a need for compliant structures to be introduced through a mixture of self-regulation and regulation if DeFi is intended to be more decentralized.

He supported his claim by saying that an audit should be done on smart contract deployment and the setup of node structures and made clear to investors– and that this is more fundamental in the DeFi’s infrastructure

The sudden fall of Celsius, which used users’ funds for investments on other platforms, shows that transparency is the key ingredient of decentralization.

Lehes contributed that people must know the use of assets pledged to a centralized entity. And that should something becomes wrong, the lack of recourse and the black box of rehypothecation will be the problem of putting assets on the shoulders of unregulated counterparties

In traditional finance, Institutions, such as banks, that take deposits have rules that govern how client funds can be used and monitored constantly. DeFi needs something similar to function on a decentralized basis consistently, but Lehes showed that more self-custody should be pushed by platforms and users alike.

He added that keeping custody of client funds is the simplest way to prevent institutions from becoming creative with them. And the retention of control over assets is enabled by the architecture of DeFi.

Ryan Shea adds that more decentralization, including self-custody, should be pushed for by users. He said that crypto lenders and companies are the same, and they respond to customer demand. Also, there are many DeFi lenders, and if the demand for decentralization by users within the crypto lending increase, they may need to vote their funds by moving them to decentralized lenders away from centralized lenders.

Is Centralization Useful?

There are several warnings that Shea offers, which relate to the need for more decentralization, implying that CeFi is beneficial in some ways.

He explained that compared to DeFi exchanges, CeFi lenders offer higher product yields. And with this, there is speculation that the lenders enhance yield or invest in riskier products through rehypothecation– collateral is lent in support of another loan to generate extra interest payments

In addition, numerous DeFi platforms don’t provide flat on- and off-ramps, denoting that a lot of mainstream users will proceed to choose the convenience of CeFi.

Shea affirmed that crypto transactions receive the application of government regulation, targeting the on-off ramp. This regulation will help put non-compliant crypto companies in check.

It is being argued that decentralization itself can’t lead to a significant reduction in the collapses witnessed by the market recently.

Shea explained that the project team quality is what matters. For DeFi lenders, the quality team will seek to deal with dramatic market events.

It can further be argued that only transparency and regulation can ascertain a significant decline in risk as far as DeFi is concerned, with no regard to if a platform is centralized or not.

In Lehes’ conclusion, he showed that layers of transparency are provided by regulating existing innovations and products. And that in the future, Investors should try to only deal with DeFi products where smart contracts and processes can be audited, the event of malpractice has a path for recourse. On the use of collateral, they have complete transparency.

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