Traditional monetary systems allow people to buy, lend, borrow, and pay only through centralized financial institutions. Centralized finance systems have gone through many phases, and all users and investors are looking for alternatives as they are concerned about power, control, authority, and conditions.
After the 2008 recession, discussions, and debates to consider new alternatives for finance started expanding. This is where blockchain, cryptocurrency, and decentralized finance came into the picture. The debates and discussions have now shifted to new technology with new rules and comparing it to the traditional system, i.e., CeFi and DeFi.
In this article, we will go through some concepts for a better understanding of CeFi and DeFi and discuss their differences.
Centralized Finance (CeFi)
CeFi is the traditional form of finance controlled by a centralized entity. It can be a government, financial institutions, or banks. It controls the fiat currency which is not handled or backed by any physical commodities, such as gold, silver, etc.
In the cryptocurrency market, CeFi refers to a centralized exchange that handles all users’ crypto trade orders. All the funds are managed by these centralized exchanges which control which coins can be listed, delisted, or traded. They also control the fees generated in the market.
The biggest disadvantage while using CeFi is that you do not own your cryptocurrencies. In the crypto market, it’s all about keys – not your keys, not your crypto. It means that if you do not own the private keys of your crypto, you do not have control over it. You do not own your crypto while buying or selling via these centralized exchanges. They can pause the buying or selling orders anytime. You are subjected to their terms and conditions and also you are subjected to the rules set by the centralized exchanges. This centralized approach generally benefits their management, systems, revenue, and other processes, not necessarily the end users. This implies a lack of safety and security concerns for users’ funds that can create vulnerabilities to users for internal as well as external threats.
Decentralized Finance (DeFi)
In the cryptocurrency market, DeFi is a term for the financial systems and services that are built on blockchain technology. In other words, it is an open financial system that provides security, transparency, and fewer vulnerabilities to the market.
DeFi enables the users to trust the technology to be open source and permissionless. It offers different services like borrowing, lending, yield farming, etc. It not only provides control, security, and visibility to your crypto but also gives you an alternative to fiat currency and traditional centralized finances. DeFi requires an internet connection and when you are connected, you can use the opportunities and leverage benefits from decentralized finance.
In DeFi, there is no central authority. It works on peer-to-peer system transactions. This eliminates the risk of control by other parties that could control your access to the system and market. DeFi provides a financial system that is available 24*7 anytime and anywhere.
The advantage of DeFi is you own your private keys, seed phrases, and wallet access that gives full control over your assets. Different DApps have been built that use blockchain technology to provide accessibility to the users.
DeFi vs CeFi
There are many differences between DeFi and CeFi. Let’s take a look at them:
Trust
In DeFi, the transactions take place through smart contracts. Smart contracts are contracts between two parties that enforce specific conditions that are met in order to enforce a transaction’s success. It is built on blockchain. In DeFi, the users control their funds. No trust from other users is needed. You can verify if a transaction was completed correctly or not
In CeFi, the system is in charge of the users’ money. It limits the access of users over their assets and can even control them to their advantage. The users must trust 3rd parties to verify transactions on their behalf.
Flexibility
DeFi does not offer flexibility. It does not provide services that can help the user to convert fiat to crypto and vice versa.
But CeFi services provide more flexibility in regard to crypto and fiat conversion. This makes it easy for the CeFi system to onboard users with better options and customer experience.
Cross-chain activities
Cross-chain swapping and transactions require latency and network addresses. This increases the technicalities and makes cross-chain transactions more complex.
Most DeFi platforms do not provide the tokens while CeFi does provide the services by taking the funds and custody of the different assets from multiple chains.
Permission
DeFi can be accessed easily without providing any personal information like KYC. It gives seed phrases to users to connect different dApps like wallets, DEX, etc.
While in CeFi, a user must have to provide personal information for verification of the identity. After the verification is successful, then only users can trade. This information can be further manipulated to their advantage.
Conclusion
The DeFi and CeFi work on the same goal i.e., to provide a system for the user to trade, however, the concepts and approaches are different. As the market will continue to grow and crypto trading will become popular, these two spaces will carry out their objectives differently.
It all depends on the investors and their wants, needs, and priorities.