CeFi Hopes and DeFi Dreams

Celsius recently gated withdrawals and Blockfi is facing a massive down round. In the bull run, centralized “storefronts” for Defi gained a lot of steam, securing backing from brand-name institutional investors, amassing deca-billions of AUM, and generating strong revenue flows. But as the market falls into bear territory, it turns out that these behemoths were built on top of chasms between TradFi and DeFi, which can widen and cave in when there are earthquakes on both sides.

We believe in a decentralized, trustless, and permissionless financial landscape. This is a good time to learn from what happened so we can continue to build the DeFi vision. Let’s examine these chasms to better understand what value these centralized platforms provided, the risk they posed, and what should be done to mitigate these risks.

Celsius, Nexos, Blockfi, and others like them (let’s call them collectively, “CeFi”) attracted users by offering returns that were significantly above what was available in TradFi markets.  With bank savings accounts yielding around 0.5%, and low-risk bonds from treasuries to AAA not offering much better, it made sense that anyone would want to do a bit better, as long as the perceived risks were tolerable.

CeFi saw an opportunity comparing TradFi yields to those in DeFi (Those two types of “yields” are far from apples-to-apples, but we’ll talk about that in a later post.).  They abstracted away the complexities of Defi and offered users exposure to a fast-growing, exciting new sector.  By providing capped returns to users, CeFi was able to create funds that were essentially 100% carry after a hurdle rate, or a high-octane carry trade.

There are plenty of helpful twitter threads about what went wrong with Celsius, so we won’t dive into it here.  Instead, I’m curious about the user mentality that drew them to CeFi.  What kept them from just stepping into DeFi directly?  What are the perceived risks of Defi, and how can we better educate, model, monitor, and mitigate them?  I interviewed some users, and while I did not hit a statistically significant sample, I did find a few rhyming themes.

1. CeFi Appeared Safer

Being a large institution with apparent legal guardrails and oversight provided some measure of comfort about the scope of “bad events” that could happen.  If things did go wrong, there was the perception that help could be reached and users would not be “on their own.”  Users thought that there would be less degen behavior and that they would have recourse.  Having fiat on-ramps also meant less chance of getting stuck. CeFi benefited from the confidence users put into “trusted” systems, rather than DeFi’s “trustless” protocols.

But CeFi companies aren’t banks.  They’re not insured or regulated.  They do not hold user funds in preferred positions, in fact, it’s quite the opposite.  CeFi systems can fail just like DeFi, and users may get a worse shake. In other words, CeFi epitomize the phrase “not your keys, not your coins.”

The Celsius gate proved that you can get stuck in CeFi.  And unlike smart contracts where it is clear how long staking and locked tokens would be in a protocol, there is no clear way to gauge CeFi gates.  But the learnings here can be applied to better the user experience in DeFi.

Currently, DeFi users must seek out protocol information and dig into smart contract mechanics to understand how their funds are used, and for how long. It is clear more education and onboarding is needed. General long-tail investors will opt for convenience, which includes having good supports desks, more education, better onboarding, and the ability on and off ramp in fiat.

2. CeFi is Better at Crypto than I’d be Myself

While this sentiment is understandable, there are certainly protocols in DeFi that provide curation and investment as a service.  The perceived risk is that there is so much going on that paralysis by analysis would be overwhelming.  While CeFi users undoubtedly understood that these companies were “doing something in crypto,” the underlying strategies were not clearly presented.  The mentality is usually, “CeFi has more information or crypto familiarity than I do myself.” But that abstraction made it more attractive, not less.

I think the chasm here is not knowing how to categorize and analyze risk in DeFi altogether.  The current DeFi ecosystem asks users to explore and learn on their own.  Seeking out alpha and building your own strategy is part of the zeitgeist.  It’s so early that established due diligence frameworks do not exist, so users develop their own tools.

From Dune Analytics to Token Terminal, projects are attempting to categorize risk vectors.  However, these are not specific to DeFi strategies and can be overwhelming.  CeFi’s simplification, though a double-edged sword, has proven powerful for users.  Instead of simplifying, however, I think DeFi can benefit from elucidating risks by strategy type, and allowing users to better understand their own risk-rewards appetite.

3. CeFi Seems Less Volatile

This sentiment is understandable, especially given the recent market drawdowns.  But if CeFi is built on top of a volatile system, it cannot escape the underlying forces.  I would argue that DeFi users expect volatility, but not CeFi users, not at this magnitude.  So in that sense, because it is masking and hiding volatility, real tail events can hit CeFi users harder. In a way, CeFi masks and shields volatility away from their users with an opaque view into their usage of funds, which leads to trouble in a bear market.

Unfortunately, there are no quick fixes for volatility.  But as DeFi evolves, as transparency increases, and risk mapping becomes clear and common, the fundamental value of many projects will emerge.  Having an accessible grasp of risk will allow users to calibrate their exposure, which will mitigate the wild swings.

What Can We Learn from This?

Ultimately, CeFi exists because the perceived risks in DeFi are not clear.  User experience is improving.  Fiat ramps are growing.  And risk is coming to the fore of many DeFi discussions.  Teams are working hard to build parameters, guardrails, and monitors so that users can gain visibility and control in DeFi.  Risk mitigation tooling will create a stronger foundation for DeFi to build back upon, and we’re excited to be a part of it.