When all said and done, it seems like the less trust needed, the lesser the fallout in crypto.
In the aftermath of crypto contagion, it is becoming clearer that the staying power of DeFi vs. CeFi is drastically different. This is best exemplified when we compare Uniswap with bankrupt Celsius Network, as both attracted users with yields superior to traditional banking.
Uniswap decentralized exchange (DEX) not only provides users with steady revenue but also rivals centralized exchange. In daily volume, it outcompeted KuCoin, at $1,088 million vs. $964 million. What can we conclude from this?
CeFi Vulnerability Laid Bare – Centralized Decision-Making
DeFi became popular for two key reasons. The first one stems from governance. Without having a governing body, the vulnerability generated from poor decisions is removed. The bankruptcy filing for Celsius Network showed this clearly.
To maintain enticing APYs between 5% to 18%, depending on the coin, Celsius ran a debt-based business model, leaving it with a $1.2 billion balance hole. In fact, Celsius relied on DeFi lending protocols to do this, as demonstrated by its obligations:
- $223 million debt paid to Maker
- $258 million debt paid to Compound
- $235 million debt paid to Aave
This was a last saving-measure to unlock $1.4 billion worth of collateral, largely in wrapped Bitcoin (wBTC) and staked Ethereum (stETH). The Celsius bet was simple – spur user growth by offering double-digit yields and then use their funds to collateralize for DeFi staking.
This model abruptly halted when the Fed’s interest rate hikes triggered a wide market selloff. One could say it was Ponzi-like in that it required perpetual expansion of the pyramid’s bottom. Others could say it overly relied on the supercycle theory of market expansion.
Either way, the Celsius fallout happened out of centralized decision-making. In contrast, DeFi governance is limited to platform development, largely directed by token holder voting.
Digital Asset Ownership and User-Governance
The other reason why DeFi became popular is true ownership. Because users connect non-custodial wallets to DeFi platforms like Uniswap, there can never be a situation in which a couple of people at the top decide to terminate access to users’ own funds.
Notwithstanding fake airdrops, hacks, and exploits, which also happen on CeFi, DeFi vulnerability comes from the market itself. Case in point, Uniswap provides gains for its users because they become liquidity providers (LPs). Then, when traders want to tap into those liquidity pools to exchange cryptos, such as from ETH/USDC token pairs, LPs receive a cut for their decentralized service.
But, because the price of those tokens can shift, up or down, impermanent loss (IL) happens. The “loss” part comes from the change in deposited value vs. withdrawn value. The “impermanent” part comes from the fact this difference can shrink.
However, IL is mitigated by trading fees. Because the protocol is decentralized, the bulk of proceeds goes to users – liquidity providers. On Uniswap, traders pay a 0.3% fee for token swaps. Out of that 0.3%, 100% goes to LPs.
On Celsius, CEL stakeholders received 80%. Recently, Uniswap (UNI) stakeholders proposed to add another flexibility layer in the form of a “fee switch”. If this protocol charge is turned on, LPs would then receive 0.25%, but the protocol itself would go from zero generation to 0.05%, filling up its liquidity reserves.
DeFi is all about self-ownership, user decisions (which liquidity pool to use), and governance via UNI token voting. At no point were CEL token-holders directing which user funds go where and for what purpose. Instead, CEL was merely used as the platform’s discount perk.
Even Sam Bankman-Fried Tried to Topple Uniswap
During the crypto contagion, FTX CEO Sam Bankman-Fried became the crypto bailout king, trying to stem the bleeding so it doesn’t affect his exchange’s core business. However, when it comes to DeFi, he saw the writing on the wall early on.
In the second half of 2020, SBF transferred $1 billion worth of Uniswap funds to SushiSwap. Equivalent to a hostile takeover for blockchains, this move was a so-called “vampire mining” attack. SBF tried to topple Uniswap’s market share in favor of SushiSwap, Uniswap’s hard-forked clone.
Uniswap responded by launching its governance and utility token UNI later on, having airdropped 400 UNI into the wallets of users who interacted with the platform. After retroactively funding brand loyalty, Uniswap remains the dominant DEX at $6.39 billion TVL, while SushiSwap was delegated to the outer fringes at $737.2 million TVL.
Uniswap Disproves SBF’s Take on DeFi
SBF ended up taking over SushiSwap, ousting Chef Nomi after a heated exchange on Twitter (NYSE:TWTR). When later asked about the future of DeFi, SBF responded with the following:
“Certainly you can imagine a scenario where it could flame out back into hibernation for a while, and that could happen with a few more disasters and not much innovation.”
Two years after that statement, not only did major CeFi platforms collapse, but Uniswap has maintained a steady level of revenue for its users.
Additionally, the protocol introduced several liquidity customization innovations with V3, cementing its dominant DEX status. Riding on this success, Uniswap Labs’ ex-chief of staff, Devin Walsh, recently proposed the establishment of the Uniswap Foundation (UF).
If the proposal passes, UF will be incorporated in Delaware, which is popular with corporations due to its expedient Court of Chancery that resolves disputes without juries.
Just like Ethereum Foundation handles the growth of Ethereum, would UF do the same for Uniswap? Walsh asked for an unlocked $74 million worth of UNI funding program over three years. Interestingly, the bulk of the budget, $60 million, would go to the Uniswap Grant Program (UGP), while the rest would be assigned for the team’s operating costs.
When all considered, it appears that Uniswap is successfully treading the path between DeFi and CeFi. Without incurring Celsius-like vulnerabilities, a small team can still run a lean, decentralized, and user-oriented operation while still adapting for the competitive future.