Understanding the Great Crypto Tradeoff

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Mainstream thought misunderstands security breaches and market failures rife in crypto organizations.

This does a disservice to the concept of true decentralization in blockchain. Commentators in crypto media used the multiple fiascos of 2022 to slam DeFi, when in fact many of these entities were only decentralized in theory, not in practice. True DeFi hasn’t actually failed yet.

TradFi (traditional finance) does fail. We saw it in 2008, most notably. And CeFi faces similar issues, such as with the FTX debacle – although more entities are now realizing a point of centralized input is necessary to make the machine tick.

If we are to see blockchain solutions match the ubiquity of TradFi, then compromises must be made. Large amounts of capital flying around at high speeds sounds great until something goes wrong.

How could Sam Bankman-Fried of FTX justify moving $4 billion of tokens between Alameda Research and the exchange? Apparently “rotating a few FTX wallets,” which they do periodically, and that it “won’t have any effect” was simply not true. There was not enough self-regulation and oversight.

CeFi entities need to maintain the ability to pull the plug at a moment’s notice, and this could actually become a prerequisite to proper protection of these funds.

The crypto dream was to create decentralized systems. But too much is at stake to allow it to become a runaway train with a total lack of accountability – or responsibility. Ultimately, central control stops services and products from going awry with potentially massive losses for customers.

Solutions are varied

Veterans of blockchain – both those building and those investing – are desensitized to claims from various projects stating they have the singular blockchain that resolves the trilemma and provides a scalable, secure and decentralized solution.

If you Google, “who solves the blockchain trilemma,” you are offered a long list of projects staking this claim. Dare to dream.

It’s somewhat detached from reality. The reality is the space is purely horses for courses – or in other words, different chains offer different functionalities. Commercial use will see businesses implement whatever works best for their specific use case.

Will the adoption of purely decentralized blockchains be possible? The short answer is yes. There will be instances, perhaps in the gaming world, where a DeFi solution is preferred or even optimal.

But when it comes to mass adoption, we can expect many enterprises to pick an option with a centralized backstop. Ideology doesn’t factor in when we’re talking about the bottom line of a business.

Translating DeFi into the real world

At the end of the day, blockchain projects are concerned with maintaining security and scalability while remaining as decentralized as possible.

And the more decentralized a mining community is for proof-of-work, the harder it is to engage in a 51% attack. But when you have far fewer miners, a 51% attack becomes a much more credible threat.

Here lies a compelling argument for a centralized aspect – possibly through validator nodes controlled by a central body – and further for the importance of taking blockchains out of their siloes and marrying their communities together by making true interoperability a possibility.

Increased rates of network traffic can’t be an issue either, or the whole system crumbles when applied to situations TradFi would normally be used in.

Right now, we have great solutions that can’t even handle traffic surges when they are tested. Outages are incredibly concerning – perhaps even catastrophic – when you have billions in value on the line. Yet, no single chain has proven it can vastly scale in a reliable way and provide regularity.

A banking solution built on a blockchain simply could not go down for 12 hours. Millions could be lost, and an untold amount of real-world problems would arise. The centralized guarantee becomes more attractive as a result.

However, it is a fact that the best-of-breed blockchains such as Bitcoin and Ethereum, and even Litecoin have managed to maintain 100% uptime. This places apparent trade-offs with the newer, less established chains –which correlates with innovation, a factor that is definitively attractive in any nascent industry – especially if the industry involves technology at its core.

Keeping CeFi honest

Crypto enthusiasts need not be disillusioned by market forces and end user needs making it unlikely for truly decentralized solutions to become the new paradigm.

This is because of the many possibilities for protocols to effectively govern the level of centralization in any one blockchain.

Interoperability makes it easy for users to en masse at the moment a CeFi entity abuses its power, exploits its users or becomes evidently too centralized for the liking of a decentralization ideologues.

Nor does the point of failure turn quite so grim, when funds and DApps can be transferred readily between chains upon outages or outright collapse.

This issue may concern developers and businesses more than the consumer, who will likely in future be oblivious to which chain they are using to make transactions. When it’s completely seamless, there is no reason for them to know.

CeFi will grow into a self-regulating space, and one of the aspects that may lose customers is excessive centralization when decentralization is possible or provides a better experience.

A protocol making blockchains interoperable can deliver the level of DeFi most crypto enthusiasts desire, without compromising on the CeFi aspects that make a blockchain appealing to enterprises. As stated before, we will likely find that different chains are optimized to serve varying purposes or use cases.

What is certain is that a collective move towards this future is set to form a crucial part of the industry’s evolution and maturation.

Toby Gilbert is the CEO of Coinweb. He attended UCL and went on to focus on the tech and telco spaces. With a proven track record of founding new startups, including having successfully invested in and exited three telecommunications companies operating in Europe, Africa and Asia, Toby invested in Coinweb, a unifying platform for connecting blockchains together in 2018, as well as co-founding and leading the Blockfort and OnRamp DeFi projects since 2019.

Featured Image: Shutterstock/Design Projects/Andre Boukreev