On November 11th, FTX, the second largest cryptocurrency exchange in the world, filed for bankruptcy, just a few days after a mass bank-run was caused by uncertainty over the CEX’s liquidity.
This is the latest in a series of crypto projects that crashed in 2022, leaving behind losses of tens of billions of dollars and millions of customers affected.
First, there was Terra Luna’s downfall along with its algorithmic stablecoin TerraUSD, followed by Three Arrows Capital’s bankruptcy.
Besides them, three centralized cryptocurrency providers crashed as well: Celsius Network, BlockFi, Voyager Digital.
This was partly because of the crypto winter consolidating in 2022 but mostly because these central entities misbehaved or mismanaged user funds.
This was a failure of centralized finance, reminding us once again the reasons we need decentralization.
But what are these more precisely and what are the solutions it brings in finance?
Let’s go back to Bitcoin, where it all began…
The idea of a cryptocurrency came as a reaction to the 2008 financial crisis provoked by the traditional centralized financial system.
When Satoshi Nakamoto introduced Bitcoin, it had in mind a financial system that wouldn’t need regulation of a central authority, in order to prevent third party interferences from changing it.
That was solved with the distributed ledger technology (DLT) that uses a decentralized network of computers that solve cryptographic puzzles in order to validate transactions on the network.
Thus, the need for an intermediary was abolished, as it was replaced by a democratic computing system only requiring trust in the underlying mathematics of the protocol.
This is how the first decentralized self-regulatory financial system was born.
Later, the development of Ethereum came with more innovation in the same direction, bringing smart contracts that enabled the development of a multitude of trustless financial products and systems.
This pushed the concept even further and set the basis for what later became known as Decentralized Finance — or DeFi.
DeFi is designed to ensure the benefits brought by Bitcoin and amplified by Ethereum: permissionless validation, transparency, censorship resistance and self-custody of assets.
Permissionless (or trustless) is a term that describes the quality of a blockchain protocol or DeFi platform of not requiring permission from a central authority or not needing investment of trust in a third party (as it is algorithmically provided).
Because of the nature of DeFi and its need to be distributed and validated, all blockchain data is publicly available, thus ensuring global transparency. Thus, the balance that an address has and the transactions it performs on the blockchain are easily verifiable anytime.
Governments can censor or restrict certain services offered by entities, but they cannot do the same in the case of computer programs. You cannot control something that does not have a central point of control.
Great power comes with great responsibility.
Self-custody comes as a necessity in a decentralized space, and it means that the user is the only one accountable for storing and managing its assets.
“Not your keys, not your coins” became a slogan in the crypto space and the FTX crash became yet another reminder of this fact. If you don’t own the private keys of the wallet in which your crypto is stored, it means that you don’t truly own that crypto.
Because of these principles, users of DEXs like Uniswap or lending platforms like Aave or Compound would never be worried about losing access to their assets. These protocols are transparent and governed by immutable smart contract logic that does not allow blockchain assets to be used in another way that the initially programmed.
Therefore, DeFi platforms and applications continue to function normally even in the light of uncertainty and market turmoil. Because this is exactly what it brings: certainty, safety, transparency, ownership. This is the power of DeFi.