DeFi vs. CeFi: The Rift That Splits the Crypto Market
|By Alex Benfield|
In the fallout of the recent FTX fiasco, we have seen several calls for more regulation in the crypto industry.
Regulation is a touchy topic in the crypto industry. It could help propel adoption … but it could also hinder the true intention of crypto’s roots: decentralization.
The first cryptocurrency, Bitcoin (BTC, Tech/Adoption Grade “A-”),was created by a community often referred to as cypherpunks, anarchist cryptography experts that wanted to separate money from centralized power.
By all accounts, Bitcoin’s founder Satoshi Nakamoto and the cypherpunks were successful in their quest with the birth of Bitcoin. They created a pre-coded money system, transparent through the blockchain and supported by a decentralized network of miners and nodes with no centralized governing body.
In the years since the creation of Bitcoin, the network has grown worldwide and an entire marketplace has sprouted up. Bitcoin can now be used for everyday transactions in numerous places around the world. And new projects are constantly created to help facilitate those transactions.
In emerging economies that suffer from massive inflation, many citizens have turned to Bitcoin as a store of value and peer-to-peer Bitcoin economies continue to grow. All of this has been accomplished with little to no regulation or oversight.
And Bitcoin has inspired a whole economy of alternative cryptos, or altcoins, with various use cases.
However, the recent collapses of centralized crypto institutions could lead to more governmental overreach and regulation, which may hamper these newfound peer-to-peer crypto economies.
How will these two systems coexist?
The short answer is they won’t. They’ll likely exist totally separately.
We will likely see two juxtaposed cryptocurrency economies sprout up in the wake of the coming regulation.
One will be a highly regulated economy that begins to onboard the “institutional money.” That economy will consist of the same traditional finance players that thrive on Wall Street, along with other players in the crypto ecosystem that play by the rules, such as Coinbase (COIN).
With additional regulatory clarity, more crypto investment vehicles will be created. This will allow more investment advisors to offer crypto exposure to their clients.
As a result, this system will permit investment advisors, brokers and other centralized money managers to custody their clients’ Bitcoin, increasing total investment in the crypto market.
The downside is this will also increase centralization.
Hardcore Bitcoiners will never accept the tradeoff of more convenience for less decentralization, therefore a secondary peer-to-peer blockchain-enabled secondary economy is likely to survive and thrive.
This system will likely use its decentralized nature to avoid regulations and will cater to those who self-custody and transact in crypto-denominated transactions in a peer-to-peer fashion.
The best current example of what the secondary system could look like is the Bitcoin Beach in El Salvador — a circular economy where prices are denominated in Bitcoin and all transactions occur on the blockchain, assisted by non-custodial middleman applications that help facilitate transactions.
This dichotomy will become even more pronounced should governments introduce central bank digital currencies. CBDCs mimic cryptocurrencies in the sense that they utilize blockchains, but that’s where the similarity stops.
CBDCs use centralized blockchains, eliminating the main appeal of Bitcoin: decentralization. These centralized blockchains allow for insight into all transactions conducted on the network, but only for a select few parties running nodes … which are most likely central banks and governments.
Governments and central banks will also retain the power to issue more currency at will, eliminating the second biggest appeal to Bitcoin: programmed supply.
Not only do users lose transparency over the network, but they’re subject to centralized parties’ ability to issue and debase the currency at will.
Governments are also actively working on combining the newfound powers of CBDCs with social credit scores and personalized carbon footprints. Now we run into an issue where centralized parties can remove you from the financial system at will depending on your social standing.
All we need to do is look back at how the Canadian government handled the Canadian Trucker protests to see how this could be a problem. Canadian Prime Minister Justin Trudeau cut off the protesters’ access to the banking system, essentially blackballing the protestors from modern society.
Ultimately, that decision led to the end of the protest. Regardless of your view of the protest itself, the idea that a democratic country can silence the voices of opposition with financial bullying is worrisome.
Given that Bitcoin and other cryptos offer an escape route from those centralized financial ecosystems, there will be plenty of people who refuse the terms and conditions of CBDCs and opt into peer-to-peer crypto economies.
I believe we’re nearing the start of this split, as we’ve begun to hear more and more from governments about their desire to create CBDCs.
We’re also likely to see new regulation introduced in the wake of the FTX saga which will give us the outline to the “institutionalized cryptocurrency ecosystem.”
The outline for this parallel crypto economy lies in Bitcoin Beach and will likely start to extend to other cities and countries in the coming years.
Believe it or not, there are governments that don’t wish to outlaw cryptocurrencies. Those countries will become havens for the crypto economy.
The next year or so will be very telling as to what this dichotomy might look like.
We’ll be watching very closely as new regulation comes, CBDC projects are launched and more circular crypto economies sprout up in developing countries around the world.
We suggest you do the same.