Defi 1 CeFi 0

Defi is the name used to refer to decentralized finance, depending directly on the blockchain. CeFi refers to centralized finance related to cryptocurrencies, the central entity is in charge of the accounting and timely management. Both differ from TradiFi, which is the world of more traditional finance (which does not use blockchain, yet).

When we think of blockchain we must specify why it is relevant here. The reason here is simple, with DeFi we have the ability to audit at all times, which protocols are solvent and which are not. With CeFi we cannot because they do not publish their balance sheets in real time and we cannot have a good understanding of the credit quality in each case. It is true that cases such as Solend make it clear that the margin of overcollateralization can be put at risk if the collateral to be liquidated is too large. But they are still highly reliable mechanisms, tested under extreme conditions.

Many CeFi companies have collapsed because they did not ask for sufficient collateral. They have not adequately covered their risks and we could not see whether they were solvent or not, we could not until the veil was lifted and we saw that they had lent without guarantees to the wrong people. The most significant example right now is Three Arrows Capital. Collapse that is dragging down a large number of investors and platforms because they didn’t take the precautions they should have. Or their counterparties did not take the necessary measures.

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A great advantage of public blockchains is that we can detect insolvency situations more quickly and accurately. In addition, they tend to concentrate transactions in a wallet and allow us to see more clearly how the money is moving. In the image we see how capital was moving out of their wallet, which makes it very clear that something is not right. Lenders were supposed to control these movements and put the brakes on when they saw the irregularities that were clear on the blockchain.

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The CeFi Celsius Network platform, at the time of publication, still does not allow deposits and withdrawals. They are also not communicating what their plan is or what they are going to do to allow reopening. In the meantime, we have been able to see the liquidation price and now know that they fully repaid their debt. But they did repay at MakerDAO. We don’t know what debts they have off chain. So their accounting remains opaque despite some transactions recorded onchain.

Using cryptocurrencies with long term potential as credit collateral is a very beneficial operation for the crypto market. Especially to allow short or bearish positions. Even if it generates cascades of liquidations and problems previously discussed. The weakness lies in under collateralization, in not guaranteeing 100% payment with debt-free assets. Credit risk is the Achilles Heel of the traditional financial system (TradiFi) and is the great challenge for DeFi and CeFi.