DeFi vs CeFi
Traditional financial services such as payments, lending and borrowing were only available via established financial institutes and banks. But it transformed with the introduction of blockchain technology. When the concept of cryptocurrency started expanding, the discussion has shifted to a new set of considerations, i.e., decentralized finance (DeFi) and centralized finance (CeFi).
To understand the comparative pros and cons of CeFi and DeFi, we first need to have a better understanding of these two concepts.
- What is Centralized Finance (CeFi)?
- What is Decentralized Finance? (DeFi)
- How is DeFi different from CeFi?
What is Centralized Finance (CeFi)?
Before DeFi was introduced, Centralized Finance was the standard for trading cryptos. It handles a stronghold over the cryptocurrency industry. In centralized finance (CeFi), all crypto trade orders are handled through a central exchange. Funds are managed by specific running the central exchange. It means you don’t own a private key that provides you access to your wallet.
Moreover, the exchange identifies which coins they list for trading or how much fees you need to pay to trade with their exchange.
Concluding the concept of Centralized Finance, you don’t own your cryptocurrencies when buying /selling via a centralized exchange. Moreover, you are subject to the rules a centralized exchange imposes on you. Also, you are subject to the rules set by the centralized exchange.
What is Decentralized Finance? (DeFi)
No exchange is involved in the decentralized exchange. The complete process operates via automated applications that are developed on top of blockchain platforms. Also, decentralized finance creates a fair and transparent financial system where anyone can participate. It allows unbanked people to access financial and banking services via blockchain technology.
DeFi aims to build an open-source, permissionless and transparent financial service ecosystem. The decentralized financial system offers services, including borrowing, yield farming, crypto lending, asset storage and more.
The benefit of using DeFi over CeFi is that you have full control over your assets and own the key pair for your wallet. Moreover, users who want to participate in DeFi need to use decentralized applications (dApps) built on the blockchain platforms to access DeFi services.
How is DeFi different from CeFi?
Though you would find many differences between DeFi and CeFi, the question is whether users should trust technology or people.
With DeFi, users trust that the technology will perform as proposed to execute on services being offered. On the other hand, with CeFi, users trust a business’s people to manage funds and execute the business’s services.
Both DeFi and CeFi deliver a wide range of cryptocurrency-related financial services. Let’s discuss some of the features and functionalities of both the ecosystems that differentiate them from each other.
Features of CeFi
- Centralized Exchange (CEX)
Using a traditional cryptocurrency exchange, for example, Binance, Kraken or Coinbase, users send funds to the exchange to manage them within an internal account. Though funds are stored on the exchange, they are kept outside of users’ custody and are vulnerable to threats in case the security measures put in place by the exchange fail.
Due to this, centralized exchanges have been the target of various security attacks. Customers on the centralized exchange do not mind sharing their personal information or putting funds into these companies’ custody as they consider central exchanges trustworthy.
Moreover, large exchanges have complete departments with customer service teams offering assistance to customers. The high level of customer support provides the customer with a comfort level, strengthening the feeling that their funds are in good hands.
- The Flexibility of Fiat Conversion
Centralized services represent more flexibility than decentralized services when turning fiat to cryptocurrency and vice versa. Conversion between cryptocurrency and fiat usually requires a centralized entity; however, DeFi services do not offer fiat that flexibly.
Onboarding customers in the Centralized Finance (CeFi) ecosystem is quite convenient and can offer a better customer experience.
- Cross-chain services
CeFi services support trading of LTC, XRP, BTC and other coins issued on independent blockchain platforms. Because of the latency and complexity of performing cross-chain swaps, DeFi services do not support these tokens. CeFi can overcome this issue by getting custody of funds from multiple chains. It is a significant benefit for CeFi as many of the frequently traded and highest-market-cap coins exist on independent blockchains and don’t implement interoperability standards.
Features of DeFi
Users do not require permission to use DeFi. With CeFi, users need to complete a KYC process to access services, which means they have to share their personal information or deposit some money before accessing services.
Users can directly access the services using a wallet and without providing personal information or depositing money with DeFi. It is because DeFi is openly accessible to all parties, without any barrier or discrimination.
Moreover, individuals who plan to build on top of a decentralized platform can do that freely. It provides a high degree of accessibility and supports collaboration within the community. Products developed within the DeFi ecosystem are designed to benefit from each other. That is why, DeFi products are also known as money legos.
The most significant benefit of using DeFi services is you don’t need to trust that the service will perform as promoted. Users can authenticate that DeFi services perform as intended by auditing their code and using external tools such as Etherscan to identify if a transaction was correctly executed.
- Quick Innovation
Another significant advantage of DeFi is its quick rate of innovation. The Decentralized Finance Ecosystem is constantly building current capabilities and experimenting with new capabilities. The build-centric nature of the DeFi space has transformed into a rich ecosystem embedded with ground-breaking financial services.
In functionalities where centralized financial services have thrived, DeFi space has been working to deliver alternative ways to solve the issue. For example, to overcome the DeFi’s inability to facilitate the transfer of incompatible cryptocurrencies such as BTC, solutions like tBTC and WBTC, that are compatible with decentralized protocols eliminate the gap by behaving as tokens pegged to the value of BTC. It enables DeFi users to access Bitcoin via DeFi without requiring to use the token directly.
Some of the real use cases of CeFi
A cryptocurrency exchange that facilitates trading, borrowing, margin trading, native stablecoin, lending, payments and more.
It is a Bitcoin Prediction Market and Exchange that runs on the CeFi model.
A cryptocurrency and fiat borrowing and lending platform.
A cryptocurrency borrowing, payments and lending platform.
An insured Bitcoin to DAI borrowing and lending platform.
A global financial infrastructure and cryptocurrency layer.
Some of the real use cases of DeFi
An aggregator of decentralized liquidity with automatic price optimization.
A decentralized predictions market.
- Nexus Mutual
A decentralized insurance tool.
A decentralized exchange.
A decentralized stablecoin minting and lending tool.
A decentralized lending and margin trading platform.
Both Decentralized and Centralized Finance aims to achieve the same goal. They plan to make crypto trading popular and improve the trading volume. However, the way these two ecosystems carry out their objectives is different.
CeFi promises security of funds and fair trade on those funds. Investors with conventional currency can also take part in crypto trading. Moreover, CeFi exchanges provide them with customer support services that DeFi services do not offer. On the other side, DeFi wants to make the space intrusion free. It provides a space for investors to implement their strategies without having to deal with an intermediary body.
Both of these models have their pros and cons. It depends on the investor and their needs. If you prefer transparency and privacy, DeFi is the right model to choose from. On the other hand, if your priority is trust, sharing of risks, flexibility and increased options to invest, you should opt for CeFi.
Our blockchain consultants can help you in identifying the right financial model for your business. We can assist you in building financial apps on top of different blockchain platforms.
Originally published at https://www.leewayhertz.com on November 17, 2020.