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NOV. 12, 2021

Yet Another Cryptocurrency Article?

Cryptocurrency is no longer a term that a selected few are aware of. This decentralized digital money that uses the blockchain technology was first introduced in 2009, when the presumably pseudonymous developer Satoshi Nakamoto created Bitcoin.

You can use crypto to buy regular goods and services, although it is also a very popular investment, similar to other assets, like stocks or precious metals. Crypto is a novel and exciting asset class, with many risks however. At its core is a system of value and when investors purchase it, they are betting that the value of the asset will increase in the future, just like stock market investors buy securities when they believe the company will grow and share prices will increase. However, there is a major difference compared to stock valuations; there is no comparable valuation metric for cryptocurrencies because there is no underlying company. The value of the cryptocurrency is connected only to investor appetite.

Although Bitcoin and Ethereum are the most popular versions of crypto, more than 13,000 different cryptocurrencies are traded publicly, according to CoinMarketCap.com, a market research website. Cryptocurrencies continue to multiply, raising money through initial coin offerings, or ICOs. The total value of all cryptocurrencies was more than $2.5 trillion on Oct. 22, 2021, having fallen off an all-time high above $2.6 trillion days earlier.

With valuation at an all time high, the discussion has now shifted to a new set of considerations and the CeFi –DeFi battle has begun. But wait a moment, what are CeFi and DeFi?

The main idea behind a centralized exchange is that all the crypto trading orders are routed through a central exchange in centralized finance (CeFi). Binance, Coinbase, etc. are quite familiar terms in the world of cryptocurrencies. What happens here is that the users create an account with these companies and use the very same platform to primarily transfer and receive funds. These exchanges, in addition to providing crypto trading services also support other services like lending, borrowing, margin trading etc.

DeFi on the other hand – or decentralized finance - is a collective term for financial products and services, built on blockchain technologies, in the public blockchain space. In simple terms, DeFi is an open and global financial system. With DeFi, you not only have control and visibility over your money but also have exposure to global markets and alternatives to your local currency or banking options. A strong internet connection turns out to be a critical aspect here. Yet another remarkable feature of this decentralized finance is that the markets are always open and there are no centralized authorities who can block payments or deny access to anything.

The launch of Ethereum paved the way for maximizing the potential of DeFi within the financial industry, thereby encouraging the businesses to build and deploy projects that formed the ecosystem of DeFi. With DeFi, a variety of opportunities to bring about a transparent and robust financial system, became a reality. Overall, DeFi offers financial services, including borrowing, yield farming, crypto lending, asset storage, and a lot more.

One of the biggest differences between decentralized finance and centralized finance is the fact that the system is regulated in the case of CeFi, whereas exactly the opposite is the case for DeFi. In centralized finance, the responsibility of safeguarding the money of the users is with the exchanges. On the other hand, the assumption behind DeFi is that the transactions would be successful as a result of smart contracts (an agreement between two parties that enforces certain rules/terms of negotiation when a particular/specific condition is met).

DeFi companies and protocols have some big advantages, starting with ruthless efficiency. Startups like Uniswap, SushiSwap, Poly, Celsius, and more are building high-volume operations with a fraction of the staffing levels and cost structures that are necessary in the existing banking industry. The permissionless, interoperable and open nature of the Ethereum ecosystem means that building a better lending algorithm does not require building an entire banking infrastructure first.

Despite these advantages, the existing financial services ecosystem is not going to give up its customer base without a fight and has some significant advantages of its own, starting with regulatory compliance. The U.S. Securities and Exchange Commission (SEC) has made it clear that “decentralization” won’t protect investor-owned companies from scrutiny and that governance tokens, which are all too often marketed and sold as investible assets, do not pass any Howey Test exempting them from regulation. Traditional finance companies know this game well and have mature processes for everything from securities registration to Know-Your-Customer compliance.

Right now, it is too early to forecast the winners, but the last two decades of technology-driven transformation should stand as a warning to legacy financial institutions.

We thank you for the continued support.

The FAM team