Decentralization is a trade-off.

Written by: Santisa

Translated by: Block unicorn

The birth of decentralized finance (DeFi) was aimed at creating an open, permissionless, and trustless financial system. Early projects like MakerDAO, Uniswap, and Compound fully embodied this idea, featuring community governance, transparency, and self-custody. However, as DeFi has evolved to its current scale, I must ask: Is it still decentralized? More importantly, does it really matter? And what can you do to address this issue?

On Crypto Twitter (CT), many people did not experience the birth of DeFi in 2017/2018 and even missed the DeFi boom of 2020. At that time, decentralization was at the core of everything. We cared about technology, checked smart contracts for scams or custody risks, and cheered for security experts who discovered vulnerabilities.

Those who trusted centralized institutions like BlockFi, Celsius, Nexo, and Genesis? They were just ordinary people who could not ride the wave of DeFi. And when these centralized entities collapsed, their users had to pick up the pieces and enter years of costly bankruptcy proceedings. This only deepened our aversion to centralization.

And now? Most participants have not experienced the trauma of a centralized system's collapse. Therefore, it is not surprising that most new DeFi projects have abandoned decentralization. Decentralization is a trade-off; you sacrifice efficiency for security. If people do not value security, why should projects make such sacrifices?

Decentralization is a spectrum

We do not have a unique definition of what constitutes a "decentralized" system. So I will try to formulate one myself. What constitutes a "decentralized" system?

• Direct custody of one's assets: Individuals directly hold the custodial rights to their assets. If the system's rules allow (e.g., the money market has sufficient liquidity, the cooling-off period has ended, etc.), you should be able to withdraw your funds without external authorization.

• Personal funds cannot be frozen: The system's operators cannot freeze or confiscate your funds. You always maintain complete control over your assets.

• The system cannot be upgraded, or at least has a long lock-up period: Immutability ensures that the rules when you enter the system remain unchanged.

• Decentralization of the governance layer: Is the system you are using sufficiently decentralized? Have blockchain participants colluded to freeze or block someone's funds? Are there multiple nodes? Is the stake distributed? Do validators genuinely perform verification, or do they merely sign the foundation's directives blindly? Do they control the entire system (e.g., L2 in phase 0)?

• External factors: Does the system rely on centralized third-party intervention to function properly? If your money market depends on oracles set by centralized risk curators, then your funds depend on the integrity of that curator.

Next, let’s see how some protocols perform in this test.

As shown in the figure, earlier projects score higher in terms of decentralization, while newer projects perform less satisfactorily. This clearly reflects market preferences.

In 2024, centralized on-chain investment funds accumulated $8 billion in deposits, with a growth rate of 2.3% for DAI/USD, while decentralized stablecoins like LUSD saw a decline of 65%.

I grew up in an environment centered around decentralization, so adapting to this new trend is not easy. I have not completely abandoned decentralization, but I am learning to adapt. Below, I will list some examples and share some advice on surviving in this environment without being eliminated.

Centralized examples in "Decentralized Finance" (DeFi)

1. Hyperliquid: A centralized exchange on-chain that does not require KYC. You send funds to an address on Arbitrum and then receive USDC on their platform. They control the funds and the platform. The only advantage is that their deposit address is public and can be verified in real-time.

2. Ethena: An investment fund primarily engaged in basic trading. Whitelisted users send them funds, which can be sold in the secondary market for LP shares. Ethena controls all operations related to funds, payments, and redemptions. USDe funds cannot be frozen.

3. Usual: Similar to Ethena, Usual operates a fund holding government bonds. They set the rules for redemptions and asset pricing. Usual demonstrates centralized risk by unilaterally deciding the redemption price for locked bonds, while Gauntlet and MEV Capital hardcode their oracle to $1 through polling.

4. MakerDAO: Maker is now an investment fund operated by a DAO. The community votes on fund allocations, including investments in centralized custodians and projects like Blocktower Andromeda and Ethena (through hardcoded Morpho pools).

5. Uniswap: Uniswap is considered fully decentralized on the Ethereum mainnet. You maintain complete control over your funds, do not rely on external data, and the smart contracts are immutable. Here we salute Uniswap!

These setups bring significant trust assumptions and many binary risks. You are either "harvested" or you are not. We have not yet seen any major collapses, but once these centralized projects fall, the consequences will be devastating: frozen redemptions, legal lawsuits, and exorbitant fees (e.g., FTX assets).

How to minimize risk

1. Loan with risk collateral: Do not hold high-risk centralized assets directly. Instead, use them as collateral for loans. If the price of high-risk assets falls, you will not incur any losses while still earning similar returns. DeFi is always a leveraged place, so there will be no shortage of places to borrow against these high-risk collaterals.

2. Withdraw during market turmoil: When the market experiences turmoil, withdraw as early as possible. You may pay some gas fees and lose a few basis points (e.g., a 100% annualized return may only equate to 18 basis points within 24 hours), but that is always better than losing all your funds.

3. Set a minimum risk premium: Decide in advance which risks are worth taking. If a high-risk investment can provide 2-3 times the benchmark return, it may be worth it. But if that gap narrows to 30%, do not be greedy.

4. Monitor on-chain activity: Keep a close eye on large transfers or internal transactions. For example, if you tracked the USD0++ exit event, you could exit at $0.99 instead of $0.9251.

5. Understand the risks: Be clear about the risks you are taking on. Know that, aside from the risks, you also need to actively monitor your positions. During market downturns, gas fees can skyrocket (300-400 gwei), so adjust your positions accordingly. If position size is an issue, consider Layer 2.

Conclusion

Decentralization was once the core appeal of DeFi. But now, many projects have abandoned decentralization for efficiency and mainstream adoption. This undoubtedly weakens the original vision, but it is also the reality of the market.

I truly believe that over time, things will trend towards centralization. We have seen the initial state of centralization, followed by a "Cambrian explosion" of user initiative, and eventually, we will see large centralized institutions dominating our every move. We are slowly transitioning to a world of on-chain centralization. Centralized stablecoins are all the rage in the market, while decentralized projects will ultimately centralize over time to remain relevant. Decentralized money markets include custodial collateral to enhance profits, decentralized stablecoin projects peg their tokens to fiat-backed tokens for stability, and decentralized exchanges completely abandon decentralization to improve efficiency. The wave of bankruptcies in 2022/2023 is a hurdle on our path to centralization. At least in the short term, the only way to prevent this is to let the current centralized groups hit a wall and ultimately "harvest" everyone.

In ancient Rome, after Augustus killed the Republic, he ruled as a dictator for 41 years. Such a long time, with rules and incentives deeply entrenched, that when Augustus died, the Roman Senate and people did not restore their freedom. They simply asked, "Who should we trust next?" I hope DeFi is far from reaching this point, and that we can temporarily escape tyranny.

So, is DeFi decentralized? Actually, no. Does it matter? That depends. If you act quickly before these emerging centralized institutions collapse, you can make a lot of money. If you are in the asset management business, then leave your ideals at the door.

Either way, staying informed and prepared is your best way to survive in this game.

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