By Hamzah Khan, Head of DeFi at Polygon
From their inception, cryptocurrencies and the blockchain industry as a whole have been built on the premise of making finance more inclusive, transparent, efficient, and most importantly, independent of the vast majority of rigid financial institutions and others. participants like Wall Street. However, as this fledgling industry continued to gain traction across the globe, “big money” players began to take notice, and massive amounts of institutional capital began to flow in, acting as one of the biggest catalysts for the constant renewal of the crypto market. peaks not so long ago.
Meanwhile, as the industry has become more and more “institutionalized”, the most successful entities in the sector have proven to be centralized crypto exchanges (CEX) and other platforms where, despite their ostensibly decentralized foundations , total control over decision-making processes was concentrated in the hands of a few people or companies. Even then, things were generally fine in all areas – until they weren’t.
Over the past few months, we have witnessed a continuing series of high-profile disasters that have engulfed some of the biggest names in the crypto industry, including the Terra network, leading lending platform Celsius, and more recently , the gigantic FTX exchange.
Although some observers may argue that these were all examples of “foul play” – that is, big competitors “bullying” each other – that doesn’t change the fact that these companies were inherently prone to such incidents due to their highly centralized nature. and the ensuing lack of transparency, where total control and power has been accumulated in the hands of a single entity.
Does this mean that the utopian vision of a decentralized global economy is dead on arrival? Not even close. However, recent examples have proven once again that only by adhering to the fundamental principles of decentralization and transparency – upon which Bitcoin itself was originally built – can the industry move forward with confidence. And there is already a sector that has perhaps come closest to this vision thanks to its inherent characteristics and principles – decentralized finance (DeFi).
The code is the law
The recent situation around Binance acquiring/bailing out FTX – then pulling away due to issues that “go beyond [its] control or ability to help” and “latest news reports regarding mismanaged client funds and alleged US agency investigations” – set the crypto industry and markets on fire. Meanwhile, this whole debacle might not even be possible in DeFi.
What sets DeFi platforms apart from their centralized counterparts is that they operate strictly on standalone smart contracts – most of which are open source, meaning literally anyone can take a peek. “under the hood” and check what’s going on inside.
Because of this, there is simply no way for DeFi platform developers to “mismanage client funds” without some additional shenanigans such as using their massive holdings in community voting. While builders can always tweak their platforms’ smart contracts later, this is often done by releasing new proposals and asking their communities whether or not they approve of the new changes. Other than that, DeFi platforms operate automatically and according to their code for the most part.
Even though this system is not 100% “bulletproof”, it is still one step ahead of centralized finance in terms of transparency and fairness, providing users with a diverse and inclusive space where they retain full control of their assets.
can’t be mean
Unlike CEXs, which hold users’ funds on their behalf, DeFi platforms cannot unilaterally do anything with people’s money. The saying “Not your keys, not your coins” has become so popular for a reason, and the collapse of FTX has just added a lot more credence to it. Essentially, it’s generally a good idea to always keep control of your assets, even when you’re actively trading them.
This is exactly what DeFi allows people to do. Operating autonomously, decentralized exchanges only facilitate transactions, but do not take custody of their users’ cryptocurrencies. Among other things, this prevents unfortunate events such as so-called “cash shortages” – situations where a CEX simply does not have enough available assets and is forced to freeze withdrawals at because of that.
Additionally, a number of CEXs have previously stated in their user agreements that customer digital assets have no bankruptcy protection “because crypto assets held in custody may be considered the property of a bankruptcy” and “could be the subject of bankruptcy proceedings”. ultimately treat users as general unsecured creditors. Or, in other cases, a CEX may mistakenly send millions of dollars worth of crypto in their custody to the wrong address purely by accident.
Communities should always be the main foundation of any decentralized platform, not some specific founder or CEO. Ultimately, the Binance/FTX drama brought to light many of the weak points and vulnerabilities so common in centralized exchanges, and proved once again why DeFi is the future of global finance.
About Hamzah Khan:
Hamzah is the Head of DeFi at Polygon where he and his team work to deliver cutting-edge Ethereum Layer 2 technology to the global gaming, digital art, and decentralized finance developer community. Hamzah first heard of Bitcoin in 2017 while studying mechanical engineering. Previously, Hamzah worked for Citibank, where he was the youngest member of the R&D team. There, Hamzah focused on building mathematical and computational models using machine learning for high-accuracy predictions for their investment bank.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.