Bridging CeFi and DeFi: Better Risk Management and More Sustainable Wealth Generation

Have you ever staked tokens on a large crypto exchange like Binance or Coinbase? If so, you are familiar with сentralized finance (CeFi) — the technology that transmits the conventional finance system to blockchain.

With CeFi, one could easily borrow the necessary tokens at a predictable rate, benefit not only from the appreciation of your portfolio but from locking up their assets to earn stable interest — not even mentioning getting easy access to the financial system, so desperately needed in underbanked areas of developing countries. So it shouldn’t come as a surprise that CeFi became widely praised as a robust and relatively risk-free investment opportunity that offers an easy entrance point to blockchain financial markets.

Well, that’s no longer the case. The recent bearish market and black swan events likeTerra’s collapse revealed a massive issue: CeFi, supposed to be riskless, turned out to experience huge problems with risk management. Three Arrows Capital, Celsius, Voyager Digital, Vauld — this is not even an exhaustive list of crypto-institutional CeFi funds that filed for bankruptcy.

So, what are the alternatives to CeFi? Why is DeFi not a silver bullet when it comes to risk management, and how can we combine the advantages of both concepts to achieve a more sustainable wealth generation?

CeFi In Crypto: More Than Just Retail Banking, Thus Dangerous

You deposit money into a commercial bank at, say, 5%. A bank lends this money at 7%. This 2% discrepancy — the spread — is the blood flow of traditional retail banking, given its predictable risk profile and stable returns. Notably, this strategy is intuitively comprehensible for investors, who can be reasonably sure that their money will be paid back.

However, there are significant downsides of retail crypto-banking, e.g. a limited return on investments (ROI) and scalability. While the cryptocurrency adoption rates are indeed skyrocketing, they are drastically lagging behind those of traditional finance. Hence, there is a low-profit ceiling for CeFi entities and a strong incentive to switch to riskier alternatives.

The crypto industry is still nascent and the lack of developed regulations results in a high level of opacity: once locked up, your funds are in full control of the custodian, and you never know the true level of risk exposure and whether the strategy is sufficiently hedged.

DeFi And Sophisticated High-Yield Strategies

Continuing the banking analogy, DeFi is to CeFi what structured finance is to retail banking — in other words, a spectrum of sophisticated high-yield instruments with extreme variability. A skillful combination of various decentralized finance opportunities results in strategies tailored to the specific needs of an investor, including the desired volatility, expected return, and risk exposure. On top of that, DeFi algorithms are transparent since they are based on smart contracts, so there is no custody or fraud risk.

Yet, this doesn’t mean risk management is more accessible in DeFi. Taming complicated derivatives and techniques require time and expertise, and plenty of technology-specific risks exist. For example, protocol vulnerabilities sometimes elude even the most pedantic technical audit, which is why you often hear of DeFi hacks and exploits. At the same time, the economic incentives can also be miscalculated, which results in unpredictable and dangerous behavior of users.

CeDeFi, A Perfect Symbiosis

What if DeFi became more accessible and straightforward? What if, instead of manually combining complex instruments, rebalancing your portfolio, analyzing protocol trustworthiness, and calculating risk exposure, you had access to the best strategies prepared for you by experts? That’s Centralized DeFi (CeDeFi): the future of crypto finance, combining the best of both worlds: the ease of access and comprehension of CeFi, with transparency and high yields of DeFi.

With these fine-tuned strategies, one could benefit from both yield farming and appreciation while at the same time using derivatives to hedge against a negative outcome, hence showing excellent performance independent of the market conjuncture. Besides that, they could capitalize on algorithmic trading, volatility prediction, and arbitrage, or leverage token farming. Most importantly, no matter the chosen strategy, a user would get full transparency on where and why his funds are going, the prospective risks and how they are hedged, the expected return rate — and all without any lockup.

The demand for flexible and robust strategies soars high in the conditions of the volatile crypto markets. A good example of this is the three new CeDeFi strategies launched by Midas in mid-August: “Soft Long” and “Soft Short” on ETH, and “DeFi Token Farming”. Aimed at different market conditions, they attracted more than $1.5M user deposits in the first 12 hours, and are projected to add $20M to the platform’s AUM in the next month. The strategies are showing a high level of performance: for one, the DeFi token farming strategy LPs spiked more than 75%. These figures prove the increased interest of CeFi users in CeDeFi solutions.

Conclusion

To sum the above, centralized finance is gradually becoming outdated: retail banking generates low yields, while alternative strategies are opaque and risky. DeFi, on the contrary, provides algorithmic efficiency and variability of instruments — yet, it is notoriously hard to grasp and is subject to its own risks.

Providing lucrative DeFi opportunities in a convenient CeFi shell is a logical evolutionary step for the industry. Add to that better risk management, sustainable wealth generation, and ease of use, and we can see the CeDeFi not just as a handy investment option, but as a new opportunity to move forward with the adoption and integration into the global financial system.