How Decentralized Are Your Crypto & DeFi Assets?

Limiting exposure to centralization is critical for keeping your assets safe in the wild west of Web3.

5 min readDec 22, 2021

There is no such thing as true decentralization. However, limiting your exposure to centralization is critical for keeping your assets safe in the wild west of Web3.

In theory, holding cryptocurrency or engaging with DeFi means cutting out the middleman — be it a bank or other centralized financial entity. But in practice, most of us interact with blockchain-based technology through highly centralized means.

Here’s why decentralization matters and how to maximize its benefits.

Disclaimer: This article was written for informational purposes only and does not constitute financial advice. There are risks in any investment, including cryptocurrency and DeFi.

Without Decentralization, Blockchain Is Just an (Expensive) Database

Blockchain’s core value proposition is decentralization.

Using a blockchain-based currency (cryptocurrency), two parties can exchange funds without trusting one another or mediating their transaction through a third party, such as a bank.

Decentralization — storing copies of the same blockchain across servers around the world — ensures that a transaction cannot be altered after the fact. If one server’s record is altered, the system rejects the change.

This enables trustless transactions between two parties, rendering the third-party irrelevant.

Making Trust Irrelevant Is Revolutionary

Blockchain’s immutability enables trustless transactions between two parties, making a third-party — banks, realtors, record-keepers, bureaucrats — irrelevant.

Cryptocurrency — the ability to exchange funds with someone anywhere in the world without a bank account, currency conversions, wire transfers, or other 20th century relics — is but the first application of blockchain.

In traditional finance, a bank would lend your savings account funds to clients while giving you zero or negligible interest. By contrast, DeFi allows the lender and borrower to transact directly.

If a borrower attempts to default on an (overcollateralized) loan, the smart contract will automatically release its collateral to the lender. No bank, paperwork, or trust is needed.

The Risks of Centralized Cryptocurrency

Not holding your own private keys means trusting a third party with your crypto.

More specifically, leaving cryptocurrency on an exchange or using a custodial wallet — a third-party-operated crypto wallet that may access your private keys — comes with significant security risks: The majority of cryptocurrency hacks occur on exchanges and hot wallets.

Coincheck’s hot wallet was hacked for $534 million (the largest hack of all time).
Coinrail, a cryptocurrency exchange, was hacked for over $37 million.
Bithumb’s hot wallet was hacked for $30 million.

Hacking a large market cap cryptocurrency’s blockchain requires immense (or impossible) amounts of computational power. As a result, most hackers target exchanges or wallets.

Simply put, the main risks associated with cryptocurrency are problems with centralization rather than decentralization.

Many DeFi Investments Are Not Really Decentralized

Unless you’re using a non-custodial platform like Gelt, getting your USD to earn a high-interest rate on a decentralized protocol is a multi-step process involving private keys, several currency conversions, several transaction fees in different currencies — along with knowing which protocol you want to use in the first place.

As a result, most people earn passive interest on their cryptocurrency through centralized platforms such as BlockFi and Celsius, which take custody of their users’ funds.

Though each company has its own approach to lending — see “How to Earn Interest on Your Cryptocurrency” — they all lend out funds through their own centralized system at their discretion. This means that the user must trust in the platform’s:

Security: How secure is a company’s infrastructure?
Lending strategy: How are loan recipients selected? Are loans collateralized? Over-collateralized?
Solvency: What do the company’s finances look like? What will happen to your funds if it ‘goes under’?

There isn’t an inherent issue with trusting a company to do its job well. There is, however, a paradox in reintroducing trust in blockchain-based technologies— which were built to be trustless.

Limiting Exposure by Increasing Decentralization

Despite the many benefits of decentralization, most people interact with cryptocurrency and DeFi protocols through relatively centralized means.

Why? Because interacting with a blockchain isn’t easy.

But when you choose decentralization over centralization, you are choosing to trust in yourself rather than a company. This comes with risks and complications: Notably, you are responsible for maintaining your private keys.

In both cryptocurrency and DeFi, the most control you can exert over your funds is through something called a non-custodial wallet.

A non-custodial wallet gives you exclusive control over your funds through private keys which only you hold. As the non-custodial wallet provider does not have access to your private keys, they cannot access your assets.

A non-custodial wallet can also be a hardware wallet (think: Trezor, Ledger, BitBox) or a software wallet (MetaMask, Bitpay, Edge). Certain DeFi protocols have their own form of non-custodial storage, such as Gelt and Argent.

A Return to Decentralization

Today, people still leave millions in cryptocurrency on exchanges.*

There was once significant upside to centralized cryptocurrency and DeFi platforms: They make it easier to invest in cryptocurrency and earn interest off of those investments.

But today — thanks to the growth of the cryptocurrency and DeFi markets enabled by centralized platforms — decentralized alternatives are more accessible than ever.

Trustlessness, at the core of blockchain technology since Satoshi’s whitepaper, is returning to prominence.

Disclaimer: Burgess does not endorse any of the projects mentioned in this article. Any descriptions of functionality and services provided are for information only. Burgess is not responsible for any damages or loss of funds as a result of using any of the technologies described above.

*Interestingly, Bitcoin balances on exchanges decreased by 48% between January and December of 2021 according to Coinglass figures.

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