DeFi is eating CeFi

Him Gajria
Sep 12, 2020 · 7 min read

TLDR: DeFi or Decentralised finance is nothing but a set of decentralised, permissionless protocols that conduct financial services without the need of a middleman or central authority facilitating it. Think of each protocol as a set of lego blocks.

Bitcoin was introduced as an alternative to fiat currencies, to act as “base money”, by servicing the following functions — unit of account, store of value, and medium of exchange. What led most of the excitement within the community wasn’t just the introduction of a functional sound money, but the introduction of the technology that enabled it. One that could disintermediate trust itself: Blockchain.

Builders in the space explored what such a system could enable, and the focus led to smart contracts. The simplest way to understand smart contracts would be to think of it as tamper-proof guaranteed code, which is executed as you would expect it to execute. What’s exciting about that? the fact that pieces of code that can run perpetually, are open, and cannot be changed is a strong primitive for functions that exist today (lending/borrowing, derivatives, legal agreements, time-stamping, storage, etc.), and newer functions that weren’t possible before (eg. Supply-elastic non-dilutive currencies like Ampleforth).

While Bitcoin was solving the problem of trust in money, Blockchain offered the means to solve the problem of trust in general. Smart contracts were the means here.

To learn more about smart contracts, read “Smart contracts for the layman”.

As the exploration and development of usecases around smart contracts began, the community was tilted towards financial applications as there was an aftertaste of Bitcoin that remained, a financial application. Moreover, what the technology dis-intermediated was trust, and financial services were full of it. So it only made sense that it would be the first target for the space to swallow.

While Bitcoin, its clones and similar currency tokens tried to serve the purpose of money, functions around said money were missing. At the end of the day, money is only as useful as what you can do with it.

Which brings us to DeFi, or Decentralised Finance. As demand for crypto-assets grow, builders in and out of the space are realising the value of smart contracts, and their potential to serve crypto-assets by building financial applications in a decentralised manner, in the spirit of the asset-class itself. DeFi is nothing but a set of decentralised, immutable protocols that conduct specific financial functions, from lending and borrowing to insurance and basic transactions. To understand DeFi we must first demystify CeFi, or Centralised Finance. Centralised institutions conduct most financial functions today:

  • Central Banks — Money, financial regulation.
  • Commercial Banks — Lending, borrowing, savings.
  • Investment Banks — Derivatives, financial contracts.
  • Exchanges — Market operations.
  • Brokers — Trading.
  • Insurance companies — Risk protection.
  • Payment Gateways — Transactions.

I call DeFi the “Financial Operating System” or FOS. While the Financial System is built on legacy infrastructure with no means to update, blockchain + smart contracts turns this archaic system into an operating system of sorts, one that is programmable and composable.

As everything gets digitised and automated, it’s only a matter of time until we see the functions mentioned above face the same fate. The foundational technologies and architecture required to make that vision a reality is already here, and the minds needed to implement said vision are heads down working tirelessly.

Ask yourself this:

Would you want to save money, trade stocks, buy property, get insurance, make transactions, lend money, with the permission of a centralised corporation that can change or shut down at any moment, a centralised corporation that risks your money for their benefit, a centralised corporation that charges you fees and sets restrictions on money you’ve earned,

OR

a permissionless, transparent ledger run by immutable code and governed by a network whose incentives are tightly aligned to protect said ledger?

I’d personally pick the latter. Unlike CeFi, DeFi also enables unparalleled access to financial services, accessible from anywhere, at anytime, with just an internet connection.

Let’s go deeper into the functions mentioned above with examples of CeFi institutions as compared to their “protocolised” counterparts. While looking at these alternatives, keep in mind that they’re decentralised, governed by entities and people all around the world, not a single corporation. Some of them are even governance-free, meaning they never change, enabling you to have confidence on the services you use.

Money

Centralised: Dollar, Euro, Pound, Rupee.

Decentralised alternative/s: Dai, Bitcoin, Ether, Ampleforth, etc.

Central Banks

Centralised: Federal Reserve for the Dollar, Reserve Bank of India for the Rupee, Bank of England for the Pound.

Decentralised alternative/s: MakerDAO for DAI, Reserve for RSV, Meta for mStable.

Commercial Banks

Centralised: Bank of America, Wells Fargo, Citigroup, HSB.

Decentralised alterative/s: Compound, Bzrx, Aave, Dharma.

Investment Banks

Centralised: Goldman Sachs, JP Morgan, Deutsche Bank, Morgan Stanley.

Decentralised alterative/s: Synthetix, UMA, Dydx, Polymath.

Exchanges

Centralised: NYSE, NASDAQ, CBOE, NSE.

Decentralised alterative/s: Uniswap, 0x, Curve, Synthetix.

Brokers

Centralised: Robinhood, eToro, Charles Schwab, Fidelity.

Decentralised alternative/s: Zerion, Zapper, Matcha, 1inch.

Asset Management

Centralised: Blackstone, Blackrock, Vanguard.

Decentralised alterative/s: Yearn, Melon, Set Protocol.

Insurance

Centralised: Geico, AXA, State Farm, Allstate.

Decentralised alternative/s: Nexus Mutual, yInsure, Opyn.

Payment Gateways

Centralised: Stripe, Paypal, Square, Venmo.

Decentralised alternative/s: Metamask, Argent, Coinbase Wallet, and literally just your address.

Composability

The simplest analogy to composability would be Legos. Think of DeFi protocols as a set of Lego blocks, with each block serving a specific function or purpose. As a user of DeFi, you you would have your account/address block, which would be your base, on top of which you would be able to add whatever functions you’d like to perform on your money. Every protocol on a blockchain can interact with any other protocol, with no limits whatsoever.

In comparison, CeFi would be best analogised as a set of walled gardens, where each function or service offered by different companies (instead of protocols) are walled off from each other keeping you from seamless interoperations.

Governance

Permissionless

While it’s early to speak on DeFi “eclipsing” CeFi, all signs point in that direction. With the digitisation and automation of everything, finance is one space that hasn’t updated itself in a long time. Fintech has been trying to bring the financial system to the 21st century, with the unfortunate need to build on archaic foundations. DeFi ditches these foundations and builds on entirely new ones. Foundations that fit the time we’re in.

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