Despite crypto’s repeated claims of decentralized finance, most protocols are quite centralized.
Most decentralized finance (DeFi) protocols are technically controlled by a small number of smart contracts whose keys are held by one person or a tiny group of insiders. These insiders usually decide which issues are put up for community vote; they also implement the smart contract changes that result from votes.
The vast majority of utility for most ostensibly decentralized protocols relies on stablecoins, most of which are controlled by corporate executives.
Proponents of DeFi often claim that they operate in a permissionless, decentralized manner. However, most haven’t progressed much beyond centralized management. Likewise, most would lose their value if their primary stablecoin de-pegged from $1.
As an obvious example, most stablecoins’ issuers can — and do — freeze certain tokens at law enforcement’s request. Basically, there’s nothing permissionless nor decentralized about one government official terminating a wallet’s ability to interact with a smart contract. Indeed, entire DeFi protocols have shut down within hours of an attorney posting a warning message in Discord.
Examples of centralized decentralized finance
Previously, Protos described DeFi’s “decentralization theater.” This theater includes MakerDAO’s hiring of centralized asset managers who are sole signatories for off-blockchain investments in real estate, bond portfolios, and commercial contracts. Less than a half dozen signers have the authority to use multi-million dollar assets to back MakerDAO’s ostensibly decentralized community.
Consider another example. Mango Markets claimed to be a decentralized financial protocol. However, an SEC complaint alleges that one man — Avraham Eisenberg — manipulated the value of Mango Markets’ native token, MNGO, to whatever price he wanted. That might not sound so strange with thinly-traded, cheap tokens. However, the SEC’s complaint worsens, clarifying that only five to 10 eligible wallets ever voted their MNGO tokens on governance proposals.
This lack of voter participation made Mango Markets essentially centralized.
Solana-based Solend DAO seems to have a similar problem with decentralizing its decentralized autonomous organization (DAO). In its first governance vote, a proposal passed by a lopsided margin of 1,155,431 ayes and 30,101 nays with one entity controlling 1 million votes.
Even bitcoin wrapped onto other blockchains is not decentralized. The CEO of wrapped bitcoin (WBTC) custodian BitGo explained his rejection of Alameda Research’s request to swap 3,000 WBTC for BTC shortly before Alameda filed for bankruptcy. BitGo’s CEO says Alameda’s request is still unapproved on BitGo’s dashboard, and Alameda Research’s bankruptcy trustees can help resolve its WBTC position as part of its bankruptcy proceedings.
The heart of DeFi: Centralized stablecoins
Almost all DeFi protocols rely on stablecoins USDC and USDT maintaining their $1 peg. Of course, USDC governance is entirely centralized with corporate executives. Executives at this CENTRE Consortium unilaterally blacklisted a USDC wallet in June 2020. It justified that move by disclosing that it had received that request from law enforcement. The ability to freeze USDC is baked into USDC’s smart contract with its blacklist function.
Only the CENTRE Consortium can use this function. It claims it will only consider using it if there is a threat to the network or a request from a “duly recognized US authorized authority, US court of competent jurisdiction or other governmental authority with jurisdiction over CENTRE.” It also says it can undo a blacklisting action.
The other major stablecoin in DeFi is Tether (USDT). In December 2022, Tether froze three addresses holding $160 million in USDT at the request of the US Department of Justice (DoJ). In November 2022, it froze FTX-related USDT on the Tron blockchain at law enforcement’s request. It also froze a wallet with $1 million in USDT in January 2022.
Tether claims it regularly works with law enforcement agencies. A data analytics company called Bloxy shows that Tether executives have frozen more than 560 USDT wallets since 2017.
More centralized stablecoins: TrueUSD
Even minor stablecoins like TUSD are just as centralized and unpredictably governed. Binance once possessed 90% of the TrueUSD supply.
On July 13, 2023, for example, Techteryx announced it was going to take control of all TrueUSD-related offshore operations. In 2020, Techteryx purchased the TrueUSD system from ArchBlock. All of that makes TUSD sound not all that decentralized in the first place.
Just a month before, in June 2023, TrueUSD halted TUSD minting through Prime Trust as TUSD briefly depegged from the dollar.
In short, the vast majority of stablecoins by market capitalization are centrally managed and not permissionless. Their wobbly $1 peg underpins vast swathes of DeFi apps. When stablecoins blacklist wallets or lose their peg, supposedly decentralized protocols can shutter within days.