Opinion | DeFi struggles to achieve decentralization, reshaping as "On-chain Finance" is the future

Cryptocurrency analyst Ignas mentioned the impact of the USDC incident on DeFi, especially how "decentralization" is somewhat of a false issue in some aspects. The cryptocurrency community has been hypnotizing itself with the idea that DeFi is decentralized, and it might be more appropriate to redefine and rename it as "on-chain finance" to better reflect the true situation of DeFi. Integrating with centralized infrastructure could also be beneficial for future development.

The unpegging incident of USDC has caused a ripple effect in the crypto market, particularly as compared to USDT, USDC has a more dominant position in the DeFi space, being considered the safest on-chain collateral asset. Compound v2 even hard-pegged USDC to 1 USD.

However, following the incident, it has become apparent that trust in USDC ultimately depends on trust in traditional banking systems and governments.

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Ignas believes that at this point, DeFi has two paths to take.

1. Reshaping DeFi: On-chain Finance

DeFi represents decentralization and trustlessness on all levels. However, even with a slight degree of centralization, it could pose a threat to all protocols:

The strength of a chain depends on its weakest link.

From the above perspective, DeFi is considered a failure because it heavily relies on:

• Centralized stablecoins

• Somewhat centralized oracles

• Web2 infrastructure: such as AWS computing power, RPC endpoints, etc.

• Relying on centralized exchanges as fiat gateways

Ignas emphasizes that governments could potentially enforce the shutdown of most DeFi protocols.

Advantages of Reshaping into On-chain Finance:

• Self-custody

• Increased liquidity for a larger buyer market

• Increased composability for new financial products

• Single source of truth to reduce reconciliation costs

Note: Ignas referenced ChainLink community ambassador @ChainLinkGod who has previously written articles opposing DeFi and advocating for on-chain finance.

FRAX's Layout for On-chain Finance

In February, Ignas mentioned that Frax Finance aims to directly interface with the Federal Reserve's main account FMA to eliminate the risks of USDC and bank failures.

While this may classify Frax Finance as centralized, it can still benefit from DeFi infrastructure and conduct on-chain transactions without censorship.

He pointed out the contradictions in current DeFi:

All DeFi cannot achieve complete decentralization and resistance to censorship. For example, the front-end interface of Uniswap is centralized under regulatory intervention, reshaping DeFi into on-chain finance can resolve similar confusions and ethical dilemmas. USDC can still serve as a core asset in DeFi, but it must be viewed as an opaque risk asset.

2. True Decentralization

Ignas believes the second path is to remove all centralized elements to make DeFi as close to Bitcoin's level as possible.

For example, abandoning USDC and using censorship-resistant assets like BTC, ETH as collateral.

Ignas listed four points but also noted the difficulty in achieving complete decentralization:

1. LUSD

Liquity's collateral stablecoin LUSD is limited to ETH as collateral, demonstrating its hedging value during the USDC collapse period.

However, in the worst-case scenario, LUSD may still be vulnerable to attacks due to manipulated oracles.

2. Maker

Maker's stablecoin DAI's collateral was heavily reliant on USDC in the past. With the impact of detaching from USDC, emergency parameter changes were urgently passed to reduce risks.

Ignas believes the USDC crisis rang the alarm for MakerDAO, pushing it further towards the Endgame Plan proposed by founder Rune Christensen.

3. Tornado Cash

Tornado Cash, a decentralized mixer protocol, was ultimately sanctioned by US regulatory authorities for involvement in money laundering.

This shows that achieving complete decentralization is possible but extremely challenging. Are protocol founders willing to take risks for decentralization? Will users interact with fully decentralized DeFi protocols at the risk of their wallets being blacklisted?

4. Curve

Curve allows users to create permissionless liquidity pools, but if the US government requests to blacklist DAI, will Curve DAO blacklist DAI through governance voting, or will it risk being sanctioned by the US?

Complete Decentralization is Too Difficult

Ignas believes DeFi should compromise, similar to how most people access internet services under regulation but can still access the dark web through specific software.

While the front-end interface of Uniswap is subject to scrutiny, the community can create other front-end interfaces through open-source code.

Similarly, if a DeFi protocol supports USDC, it cannot claim to be decentralized.

Ignas concludes:

The collapse of USDC has put DeFi in an awkward position. Claiming to be decentralized, yet the risk comes from traditional finance. Now it should be clear that DeFi is not as decentralized as it pretended to be in the past. It should be reshaped as "on-chain finance" to better reflect the true state of DeFi. We can call it DeFi, but what we really mean is on-chain finance.