Neither the author, Tim Fries, nor this website, The Tokenist, provide financial advice. Please consult our website policies before making any financial decisions.
Post crypto contagion, it is becoming increasingly clear that the staying power of DeFi vs. CeFi is drastically different. This is best illustrated if we compare Uniswap to the now-bankrupt Celsius Network, as both attracted users with returns superior to traditional banking.
Uniswap’s decentralized exchange (DEX) not only provides users with steady income but also competes with the centralized exchange. In daily volume, it surpassed KuCoin with $1,088 million versus $964 million. What can we conclude from this?
Disclosed CeFi Vulnerability – Centralized Decision Making
DeFi became popular for two main reasons. The first arises from governance. Without a governing body, the vulnerability created by bad decisions is eliminated. The Celsius Network filing for bankruptcy made this clear.
To maintain tempting APYs between 5% and 18% depending on the coin, Celsius ran a debt-based business model, leaving a balance sheet hole of $1.2 billion. In fact, Celsius relied on DeFi lending protocols to do this, as evidenced by its commitments:
- $223 million in debt to Maker paid off
- $258 million debt paid to Compound
- $235 million debt paid to Aave
This was a last-ditch austerity measure to free up $1.4 billion worth of collateral, mostly in Wrapped Bitcoin (wBTC) and Stacked Ethereum (stETH). The Celsius bet was simple – spur user growth by offering double-digit returns, then use their funds to collateralize for DeFi staking.
This model came to an abrupt halt when the Fed’s rate hikes triggered a broad market sell-off. You could say it was Ponzi-like in that it required constant expansion of the bottom of the pyramid. Others might say it relied too much on the supercycle theory of market expansion.
However, the Celsius fallout happened out of centralized decision-making. In contrast, DeFi governance is limited to platform development, which itself is largely driven by token holder voting.
Digital asset ownership and user management
The other reason DeFi became popular is true ownership. As users connect non-custodial wallets to DeFi platforms like Uniswap, there can never be a situation where a few people at the top decide to end access to users’ own funds.
Fake airdrops, hacks and exploits notwithstanding, which also occur on CeFi, the DeFi vulnerability comes from the market itself. For example, Uniswap offers profits to its users because they become Liquidity Providers (LPs). When traders then want to tap into these liquidity pools to exchange cryptos, for example ETH/USDC token pairs, LPs get a cut on their decentralized service.
However, as the price of these tokens can shift up or down, Impermanent Loss (IL) occurs. The “loss” portion is the change in value deposited versus withdrawn value. The “fickle” part comes from the fact that this difference can shrink.
However, IL is tempered by trading fees. Since the protocol is decentralized, the bulk of the proceeds go to the users – liquidity providers. On Uniswap, traders pay a 0.3% fee for token swaps. Of that 0.3%, 100% goes to LPs.
Uniswap V3 paid fees to liquidity providers. Photo credit: Dune Analytics (@gammastrategies)
At Celsius, CEL stakeholders received 80%. Recently, Uniswap (UNI) stakeholders suggested adding another layer of flexibility in the form of a “toll counter”. If this log fee is activated, LPs would receive 0.25%, but the log itself would go from zero generation to 0.05%, replenishing its liquidity reserves.
DeFi is all about ownership, user choices (which liquidity pool to use) and governance through UNI token voting. At no point have CEL token holders determined which user funds go where and for what purpose. Instead, CEL was merely used as a platform discount benefit.
Even Sam Bankman-Fried tried to take down Uniswap
During the crypto contagion, FTX CEO Sam Bankman-Fried became the crypto bailout king, trying to stem the bleed so it wouldn’t affect his exchange’s core business. When it came to DeFi, however, he saw the writing on the wall early on.
In the second half of 2020, SBF transferred $1 billion worth of Uniswap funds to SushiSwap. This move corresponds to a hostile takeover for blockchains and was a so-called “vampire mining” attack. SBF attempted to dump Uniswap’s market share in favor of SushiSwap, Uniswap’s hard-fork clone.
Uniswap responded by later launching its governance and utility token, UNI, after dumping 400 UNI into the wallets of users interacting with the platform. After funding brand loyalty retrospectively, Uniswap remains the dominant DEX with $6.39 billion TVL, while SushiSwap has been delegated to the outer fringes with $737.2 million TVL.
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Uniswap refutes SBF’s take on DeFi
SBF eventually acquired SushiSwap, ousting Chef Nomi after a heated exchange on Twitter. When later asked about the future of DeFi, SBF responded as follows:
“You can certainly imagine a scenario where it could go back into hibernation for a while, and that could happen with a few more disasters and not much innovation.”
Sam Bankman Fried
Two years after this statement, not only did major CeFi platforms collapse, but Uniswap has also maintained a consistent level of revenue for its users.
Additionally, with V3, the protocol introduced a number of liquidity adjustment innovations that cemented its dominant DEX status. Building on this success, former Uniswap Labs Chief of Staff Devin Walsh recently proposed the creation of the Uniswap Foundation (UF).
If the proposal is accepted, UF will be incorporated in Delaware, popular with companies for its convenient Court of Chancery, which adjudicates disputes without a jury.
Just as the Ethereum Foundation handles Ethereum’s growth, UF would do the same for Uniswap. Walsh asked for a $74 million UNI funding scheme to be unlocked over three years. Interestingly, the bulk of the budget, $60 million, would go to the Uniswap Grant Program (UGP), while the remainder would go towards the team’s operational expenses.
All in all, Uniswap seems to be successfully walking the path between DeFi and CeFi. Without suffering Celsius-like vulnerabilities, a small team can still run lean, decentralized, and user-centric operations while adapting for the competitive future.
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