Why (Centralized) Crypto Projects Fail?

Why (Centralized) Crypto Projects Fail?

The crypto industry has been divided along the line of idealistic convictions ever since its inception. The original blockchain – Bitcoin, was intended as a decentralized haven, an embodiment of the principles outlined in Satoshi Nakamoto’s White Paper. Bitcoin retains its status as truly decentralized, and the most secure blockchain network in the industry.

This very etalon of decentralization is being superposed against the vast majority of other projects inhabiting the industry, which have, in essence, steered away from the original concepts to become blockchain-based reflections of traditional financial structures. The irony of the decentralized industry is that the dominant share of networks, exchanges, projects and wallets are in fact centralized.

Indeed, the largest exchanges operating on the market, such as Binance, KuCoin, and many others are centralized, abiding by the local laws and regulations of the countries they operate in. Such a paradox is being put up as the main argument for the corruption of the blockchain industry when adherents of centralization and decentralization clash.

The Boons And Pitfalls

Centralization is the norm in the global economy, governance structures, businesses, and even family matters. Having a central authority not only allows for the establishment of a single point of decision-making, but also creates a convenient vent for delegating or dumping responsibility. Though convenient as a means of freeing up the majority of system participants from having to govern it and letting them deal with their own responsibilities, the centralized model is inherently flawed. Corruption, single-access point failure, tampering with records, and many other avenues of interference in the operation of the system are common for centralized structures.

Decentralization came along as a panacea for the issues of centralization with the advent of blockchain, allowing the network to do away with a centralized authority through the dispersion of governance and transaction processing via delegation across countless nodes. The immutability of records, lack of intermediaries, and governance based on voting rights given to users are the main attributes of the blockchain that position it profitably as a reliable infrastructure for the integration of decentralized governance.

However, decentralized structures are not recognized the world over as legal, and are therefore unacceptable as infrastructures for financial services that the cryptocurrency industry is best known for. Exchanges and financial facilitator services like crypto bank card gateways, as well as wallets for retail customers, have to abide by KYC, or Know Your Customer, as well as AML – Anti Money Laundering laws. Both of these mandatory procedures automatically negate decentralization by forcing users to do away with anonymity. The platforms, on the other hand, have to establish representative offices to abide by local laws, pay taxes and comply with international financial regulations.

As such, decentralization is indeed a sound and transparent system of governance, but one that does not fit into the framework of current global legal frameworks.

But They Fail

Though centralized systems are legal and attractive for users by virtue of their legality and ability to provide both compliance and accountability, they are inherently insecure and prone to all of the pitfalls that plague them. The opponents of decentralization are eager to point out the failures of the rapidly developing Decentralized Finance industry.

However, though dubbed Decentralized, most of the services currently in DeFi are actually centralized, forming so-called CeFi – Centralized Finance. The horrendous amounts of losses attributable to DeFi in the first quarter of 2022 alone amount to a 695% increase in hacks resulting in billions of losses in Q1 of 2022 included such notable cases as the theft of $320 million from the Wormhole protocol, another $80 million from Qubit Finance, and so on. Around $1.3 billion were lost to exploits, hacks, security breaches of every kind imaginable, and banal disregard for basic personal information security measures.

But all the projects afflicted are CeFi, not DeFi, like 3AC, or Three Arrows Capital fund, which suffered a catastrophic failure in July of 2022. Until recently, 3AC was one of the largest crypto hedge funds managing over $10 billion in assets, a gigantic sum for the crypto market. Founded by Zhu Su and Kyle Davies in 2012 in Singapore, the fund prospered and was considered to be one of the ‘adults’ of the industry, showing stellar results.

However, as the crypto market entered another ‘crypto winter’ stage and capitalization collapsed, the credit lines 3AC had been issuing went bust and it filed for Chapter 15 bankruptcy in the US on the 1st of July. The full list of debts and assets is still unknown since the investigation has just began, but regulators are now certain that 3AC was taking risky actions by uncontrollably borrowing money from all across the crypto industry for further investment into crypto projects issuing cryptocurrencies, NFTs, GameFi assets, and so on.

The complete lack of transparency of 3AC that it had shadowed behind its prominent name allowed the company to borrow money under the guise of market trust. But problems started when the TerraUSD and Luna blockchain collapsed in May of 2022, resulting in the loss of over $42 billion for investors. 3AC had invested in excess of $200 million in Luna, losing all of them. As a result of Luna’s collapse, 3AC could not repay $270 million to exchange Blockchain.com and defaulted on another $670 million loan from broker company Voyager Digital. Centralized governance at its finest.

Aforementioned Voyager Digital paints another sad chapter in the long history of centralized fund failures as it filed for Chapter 11 bankruptcy on July 5 after freezing customers’ withdrawals, deposits and trading ability. Though many similarities can be traced in the case of 3AC and Voyager due to Luna’s impact on their operations, the difference between the bankruptcies of 3AC and Voyager is the fact that Voyager applied to renegotiate the terms of loans with creditors to somehow stay afloat. In the end, Voyager gave a $350 million loan to 3AC and 15,250 bitcoins, which 3AC could not pay back, sending both projects down the vicious spiral of doom.

The infamous Celsius crypto lending protocol is another victim of Luna’s collapse. The company suddenly froze withdrawals, swaps and transfers from customer accounts on June 12, sending reverberations of panic all across the market. On July 13, the protocol filed for bankruptcy stating that they hold only $4.41 billion in assets against $5.5 billion in liabilities.

Celsius’ woes started when it staked 410,000 Ethereum worth $460 million at that time in Luna. In essence, the investment meant that the funds were locked when users panicked after Luna’s failure and started withdrawing their money. Since the company did not have the reserves to satisfy users’ demands, it simply froze transactions. But Celsius’ problems started long before the onset of the ‘crypto winter’, as it took some collateralized loans in the amount of $756 million a year earlier repaying it successfully. However, in July of 2021, one of the lenders stated that Celsius did not pay the money on time and Celsius still owned $439 million, casting a dark shadow on the company’s reputation.

At a Crossroads of Convictions

The crypto market has not yet seen a single case of failure of a truly ‘decentralized’ project. All those that have failed while claiming to be decentralized were, in fact, centralized participants of the broader decentralized industry.

The examples of 3AC, Celsius and countless other market participants that have suffered from poor investment decisions, hacks, product failures, breaches and other troubles, illustrate that decentralization in the fashion of the Bitcoin network is a powerful security layer for both projects and users. As long as projects retain centralized structures with narrow circles of decision makers, network failure points, centralized administrative panels, custodial wallets, and compliance with the archaic requirements of the traditional financial system, the failures will continue.