Supercharging DeFi development with TradFi practices

Despite its over US$100 billion size, the DeFi market is still new and growing at a steady pace. To accelerate the growth and accessibility, the sector might also need to apply some practices from traditional finance.

While some people in the DeFicommunity oppose this idea, I believe a certain level of centralization, as well as the implementation of a few battle-tested methods of the TradFi and CeFi, can help tremendously to boost development and overall user experience.

Adopting TradFi Tools Won’t Make DeFi Centralised

For DeFi protocols, CeFi and TradFi methods, practices, and tools can come in really handy, considering they are incorporated properly. These can range from seamless UI/UX design accessible to people not knowing about crypto to different centralised finance primitives that projects can implement in a decentralised way.

Here, the key focus is on risk management tools, such as transaction limits, off-chain monitoring, machine learning, and quant analysis, that are widely utilised in the TradFi and CeFi markets.

While some in crypto believe otherwise, establishing certain caps and limitations to improve a project’s platform’s security and efficiency doesn’t mean it can’t be permissionless. On the contrary, even if the protocol uses centralised tools in its risk management processes, community members can still approve or even choose the ones to integrate, which would make them a part of a larger decentralised system.

Like in the case of proposals focusing on improving other aspects of the ecosystem, the developer team and token holders can use the project’s governance mechanism to suggest using third-party TradFi or CeFi tools and appoint teams to operate them. If the community approves it, we can safely conclude that it represents a decentralised decision concerning an increasingly centralised part of the platform.

As they aren’t enforced by a company or another single entity but chosen by the users themselves, DeFi projects can leverage the community governance mechanism to introduce CeFi tools for their platforms without undermining the core principles of decentralisation.

DeFi Projects Still Take Centralised Management

A great portion of the digital asset community consists of smart people who strongly believe in the idea of decentralisation.

That said, it is a complex concept, and some of them may be overly optimistic in this field. While trying to develop new financial systems that can operate without human interference and remain sustainable even without a centralised team behind them, they also tend to forget about human behaviour and habits. 

Even if we look at a fully decentralised dApp project or blockchain network with transparent on-chain governance, most of them have centralised entities or major token holders (a couple or more) sustaining the network or influencing the governance decisions. Despite being permissionless overall, the ecosystem still depends on decisions or proposals from active members, quorums and unity in terms of accepting the proposals. One can argue that a fast decision-making process needs some level of centralisation – otherwise the path forward will never be agreed upon.

However, like in any democracy, people can be elected to govern and decide on matters. In the case of decentralised finance, it is natural enough for a centralised group (the founding team or core developers) to remain in charge of building the ecosystem or managing the application.

Of course, this doesn’t mean that this entity can exercise control over the whole platform – but on the contrary. The community is the one that elects a governing group for the project, who, in turn, proposes new upgrades, features, and solutions to important issues in a similar way as the government introduces new laws for a nation.

Investors Want Better DeFi Security

In addition to enhancing their platforms by, for example, improving frontend performance or creating a more user-friendly UI/UX, decentralised finance projects can also leverage CeFi methods and tools to introduce security measures that protect their users more efficiently.

Regarding that, investors who come to this sector from TradFi often find themselves in need of extra assurances that their funds will be safe. And they have valid reasons for that. In Q1 2022, 97% of the $1.3 billion crypto stolen originated from DeFi protocols, which is over half of the $2.3 billion loss the decentralised finance market suffered throughout a whole year in 2021.

Considering the $130 million Cream Finance flash loan exploit or even the devastating death spiral of the UST algorithmic stablecoin that drove the price of Terra’s LUNA token by 99.99% in a few days, the DeFi sector features much more significant risks than TradFi. Combined with the constant dangers of falling victim to a rug pull, a pump and dump, or another fraudulent scheme, institutional investors remain hesitant to join the decentralised finance market.

Fortunately, the introduction of time-proven CeFi tools can help DeFi protocols enhance their platforms’ security, easing the worries of investors as well as improving the trust and integrity of the sector as a whole.

For example, implementing proper TradFi risk management practices, such as time delays on suspicious transactions, automatic fraud detection, and on-chain limits for deposits and withdrawals or capping liquidity, can empower developers to react faster to possible vulnerabilities and ensure higher safety of the application as a whole.

While such security measures won’t compromise the ecosystem’s decentralisation, they will make the platform safer without negatively impacting the average user.

CeFi Practices to Boost DeFi Development

As they can’t happen all at once, big changes require time to take place.

By letting the community decide on them, the DeFi sector will be able to gradually introduce proven CeFi practices, tools, and procedures without going against the principles of decentralisation. It only requires time, patience, and maturity both within and outside the crypto industry.

As more and more people come to work in DeFi after quitting their TradFi jobs, they will bring valuable experience, ideas, and skills to the sector.

This, in addition to the growing number of investors, institutions, and startup founders, will help the decentralised finance market tackle its most crucial challenges and develop organically at a faster pace.

By Kate Kurbanova, co-founder and COO of Apostro, a risk management platform that provides economic security for crypto projects by preventing smart contract exploits.