Centralized Finance (CEFI) VS. Decentralized Finance (DEFI)
The gap between centralized finance and decentralized finance (Defi) is an often disputed topic in the world of cryptocurrencies (Cefi). The cryptocurrency that most closely resembles the spirit of crypto is DeFi, which is based on blockchain technology and operates peer-to-peer without a centralized intermediary. CeFi can include traditional financial markets with go-betweens like banks, platforms that provide some of the same DeFi technologies, and cryptocurrency exchanges. CeFi depends on centralized organizations to facilitate, manage, and safeguard users’ financial activities.
When prominent players failed, several CeFi exchanges came under attack from cryptocurrency natives, which damaged investors. When the market crashed this year, Celsius, a centralized crypto bank, went bankrupt, depriving millions of small and large investors of their money. Being run by open source code and having all its transactions made public and transparent, True DeFi doesn’t need any trust. CeFi requires users’ confidence while maintaining some transactional privacy.
What Is DeFi?
Defi is a recently coined phrase, and its application in real life is even more recent. Since Ethereum is the most well-known decentralized network and has a very straightforward mechanism to add smart contract functionality on top, most DeFi actions take occur through it. The decentralized software’s functions are carried out using the Ether coin. For individuals who have faith in the Ethereum network’s future, it is frequently used as an investment.
You can run Defi applications on other decentralized networks. Solana and Ethereum are frequently contrasted because of Solana’s faster speed and reduced security. While Solana can process transactions more quickly than Ethereum, it has a much more centralized network, with many technical users wary of it. Because Solana is harder to program on, there is a significant disparity in developer activity between the two blockchains.
What Is CeFi?
Any centralized organization that offers access to DeFi technologies like applications and tokens is known as CeFi in the crypto ecosystem. The ease of onboarding is the main factor keeping consumers on CeFi. Users can enter their information and credit cards into CeFi’s apps on the app store as they would when opening a regular bank account. Since these crypto users do not possess their private keys, the CeFi entity—rather than the user—has custody of the exchanged crypto assets, similar to a bank or brokerage firm.
How Is DeFi Different From CeFi?
Checking a thing’s form of governance is one crucial way to determine whether it is Defi or Cefi. CeFi is the company that makes decisions, if there are any. A typical illustration would be a trading website like Coinbase. Something is probably DeFi if it is administered by a decentralized autonomous organization (DAO). Examples include the decentralized exchange Uniswap and the peer-to-peer lending platform Aave.
CeFi entities keep private keys of users. In Defi, the owner of the crypto assets and the person strictly responsible for holding the keys are the same person. With the aid of this function, DeFi users can use Web3 and access various dApps. Users of CeFi are limited to trading and rely on banks or exchanges.
Power arrangements are frequently mentioned while discussing centralization. Centralization occurs when decisions are made by one organization or a small group of people. The same is true for a small business that acts as an intermediary to earn from transactions. Decentralization would include a large number of people influencing governance. Peer-to-peer architectures are also an example of devolution.
Defi platforms aim to be open to all users, but CeFi platforms might grant or deny access to their services. Permission also relates to the need for a business or bank to confirm your identification under the Know Your Customer (KYC) regulations. The decentralization thesis mostly opposes the need for KYC information.
Because smart contracts are governed by code, and the rules are prewritten in decentralized society, the system is unreliable. Therefore, it would be regarded as irresponsible in a non-custodial context. You put your trust in another individual or group to do what they claim they will do in a custodial situation.
Having your keys has apparent benefits, but it also puts more burden on you. There is no recovery procedure if your password and seed phrase is lost. When deciding to use DeFi, consider caution.
DeFi VS CeFi Use Cases
Peer-to-peer lending and borrowing, derivatives, decentralized exchanges, synthetics, and DAOs are a few examples of the many applications for DeFi. Defi is a digital native with an edge over traditional financial and corporate structures thanks to its ability to finalize transactions instantaneously on the blockchain. Law is codified in DeFi.
Although CeFi has a poor reputation among crypto enthusiasts, it has valuable use cases. For instance, trading platforms are an excellent application for CeFi. Not everyone interested in cryptocurrency wants to manage their keys. Some people are more likely to lose their seed phrase than it is that the centralized trading platform they use would fail.
Limitations of DeFi vs CeFi
- Central point of failure
- Requires trust
- Can offer protection and backup for instances of error and fraud
- Difficult to onboard new users
- Loss of keys is a permanent loss of funds
- Less recourse when fraud. mistakes or loss occurs
CeFi and Defi both have a place in the rapidly expanding crypto community. They both have different advantages, yet their responsibilities are significantly additional to one another. DeFi can be safer when centralized organizations fail and offer far more capability. CeFi provides more ways to retrieve money if the password is lost and is a more straightforward approach to introducing new customers to cryptocurrency. Defi is an option for seasoned users who want to take advantage of Web3, while a rookie trader is more likely to start by experimenting with a CeFi trading platform.