DeFi vs CeFi: A Comprehensive Comparison Guide
DeFi vs CeFi: A Comprehensive Comparison Guide
What Is the Definition of Centralized Finance?
Centralized finance (CeFi) services, like centralized crypto exchanges, are run by centralized corporations. Most CeFi service providers follow the regulations stated by the local governments where they operate. These regulations make Know-Your-Customer (KYC) and Anti-Money-Laundering (AML) policies necessary for centralized financial organizations such as exchanges and trading platforms.
CeFi centralized exchange (CEX) stores your cash in custodial wallets held by centralized organizations and institutions. These crypto wallets store users’ private keys. As a trade, such companies provide users with a wide range of benefits. One of the most common solutions allowed by centralized finance is cryptocurrency trading.
Real-world Use Cases of CeFi
Users can purchase and sell crypto assets for quick delivery on CEXs that provide spot trading services. Spot trading is available with most CEXs, including Coinbase, Kraken, Binance, KuCoin, Huobi Global, and FTX.
Some CEXs offer crypto derivatives such as futures, perpetual contracts, and options. Users can trade perpetual and futures contracts on Binance, Deribit, Bybit, and BitMEX, for example. Derivatives allow traders to speculate on the underlying crypto asset’s price.
Grayscale Investments, Galaxy Digital, BlockFi, and Bitwise are asset management service providers that handle crypto assets on behalf of their clients.
To receive staking rewards, cryptocurrency users can stake their currencies on CEXs such as Gemini, Binance, Coinbase, KuCoin, and Kraken.
Borrowing digital assets is feasible on sites specializing in cryptocurrency loans, such as CoinRabbit, Nexo, and Nebeus. They allow users to borrow money (in fiat or cryptocurrency) against their crypto assets, which serve as collateral for the loan.
Expert WEB3 Development
We build decentralized applications and smart contracts for a variety of uses.
Technical Strengths of CeFi
Centralized exchange (CEX)
The ability to use a CEX is one of the earliest and most crucial features. These are classic cryptocurrency exchanges in which consumers submit funds to the exchange and manage them through an internal account. As useful as this characteristic is in the ever-changing crypto sector, it is also the reason centralized exchanges have recently been the target of several circumstances.
The fiat conversion’s versatility
As the Web2 ecosystem transitions to meet the growing storage requirements of Web3, centralized services have become the go-to option. They offer a familiar handshake for this transformation, providing greater flexibility than decentralized providers when switching between fiat and crypto assets. Usually, centralized organizations are used to converting crypto assets to fiat cash. On the other hand, decentralized finance (DeFi) services are less adaptable compared to CeFi, and they don’t rely on centralized entities for asset conversions.
CeFi services offer a distinct advantage over DeFi in that they allow for the trading of on-chain coins like LTC, XRP, BTC, and other tokens frequently issued on independent blockchain platforms. DeFi, on the other hand, lacks support for these tokens due to the complexities and delays associated with completing cross-chain swaps. Despite efforts to streamline this process, DeFi has yet to match the seamless functionality provided by CeFi. By acquiring custody of cash from multiple chains, CeFi can overcome this obstacle, which is particularly critical given that many of the most commonly traded and highest market cap coins exist on independent blockchains that lack interoperability standards.
What Is Decentralized Finance?
DeFi, which stands for “decentralized finance,” is a subset of blockchain-based finance that operates independently of traditional financial institutions. Instead, it makes use of blockchain-based smart contracts. A smart contract is a piece of code that runs automatically on the blockchain and cannot be modified. The blockchain processes transactions in a smart contract without the involvement of a third party.
DeFi has a variety of applications. Anyone can use DeFi platforms to lend or borrow money, speculate on price changes with derivatives, trade cryptocurrencies, earn interest on funds, and more. For the time being, DeFi applications primarily serve the following purposes: providing peer-to-peer or pooled lending and borrowing platforms as well as enabling DEXs (decentralized exchanges), tokenization, and prediction markets.
Real-world Examples of DeFi
Borrowing and crypto lending in DeFi
One of the most common use cases in DeFi is open lending protocols. DeFi lending and borrowing have numerous benefits, including speedy settlement, no KYC, fewer to zero collateral requirements for borrowing, and no credit checks. Lending and borrowing on DeFi protocols occur on a peer-to-peer blockchain that requires no trust and is open source, making it a safe and quick trading platform.
Monetary banking services
Monetary banking service is an often-mentioned use case for DeFi because it provides simple mortgaging services, stablecoin issuance, and insurance. As the blockchain sector grows, so does the necessity and demand for generating fiat-backed stablecoins. Conventional mortgage services necessitate the use of intermediaries, which can be costly and time-consuming. Smart contracts on a public or permissioned blockchain can dramatically cut underwriting and legal fees.
The most common applications of DeFi are decentralized marketplaces or exchanges. Traders can easily sign up on a decentralized exchange (DEX) and lend, borrow, or trade their crypto assets without the need for an intermediary. Uniswap and Pancake Swap are two popular DEXs.
Yield optimization is a technique that employs data analytics and optimization approaches. DeFi software can automate and optimize the compound of yields obtained from staking, pooling, and other interest-bearing assets. DeFi yield optimization is accomplished by employing computational strategies to obtain the greatest rates on crypto transactions.
Yield optimization is also known as yield farming. A smart contract executes the process of reinvesting your crypto winnings so you can receive optimum returns in yield optimization.
Technical Strengths of DeFi
DeFi is known for its permissionless nature, meaning anyone can participate in the network without any formal approval or authorization. This openness is a core principle of DeFi, and it allows for a decentralized financial system that is accessible to anyone with an internet connection. Unlike traditional finance, which is often subject to strict regulations and controls, DeFi services perform in a trustless and decentralized environment, where all transactions are recorded on a public blockchain that is immutable and transparent. This permissionless model has the potential to disrupt the traditional financial industry by providing greater financial inclusion and enabling new forms of economic activity.
The most significant advantage of using DeFi services is that you do not have to rely on the service to work as advertised. Users can ensure that DeFi services work as expected by auditing their code and utilizing external tools like Etherscan to determine whether a transaction was correctly processed.
DeFi’s most innovative edge is its rapid rate of invention. The decentralized finance ecosystem is continually improving existing capabilities and experimenting with new ones. The DeFi space’s continual drive to innovate has transformed it into a thriving ecosystem replete with groundbreaking financial services. DeFi space has been working to give alternate approaches to handle the issue in functionalities where centralized financial services have developed.
Benefits and Disadvantages of CeFi vs. DeFi
- Established institutions: Established financial institutions typically operate CeFi platforms with a long history of providing cryptocurrency-related financial services.
- User-friendly interfaces: CeFi platforms are generally designed to be user-friendly and easy to use, making them accessible to a wider range of people.
- Customer support: CeFi platforms typically offer customer support services to assist users with their financial needs.
- Centralized control: CeFi platforms are controlled by a central authority, which means they can be vulnerable to hacking and fraud.
- Lack of transparency: CeFi platforms may not always be transparent about their fees, processes, or policies.
- Limited access: CeFi platforms may not be accessible to individuals without a bank account or those living in areas without access to traditional financial services.
- Decentralized control: DeFi platforms are controlled by a decentralized network of users, making them less vulnerable to hacking and fraud.
- Transparency: DeFi platforms are generally more transparent about fees, processes, and policies.
- Open access: DeFi platforms are accessible to anyone with an internet connection, regardless of location or financial status.
- Complexity: DeFi platforms can be complex to use and require a certain level of technical knowledge.
- Volatility: DeFi platforms can be subject to volatility due to the decentralized nature of their networks.
- Limited regulatory oversight: DeFi platforms are generally not subject to the same regulatory oversight as CeFi platforms, which can create a higher level of risk for users. Risk factor security relies on the community to report vulnerabilities, and many protocols offer bug bounties or other incentives for users to identify and report security issues.
Widespread DeFi Use Throughout the Globe
DeFi has seen a significant increase in adoption globally over the past few years. Here are some of the key trends and developments in the adoption of DeFi around the world:
- Increasing number of users: The number of DeFi users has been steadily increasing, with over 10 million unique addresses interacting with DeFi protocols as of early 2022.
- Growing ecosystem: The DeFi ecosystem has been expanding rapidly, with new protocols and applications being developed regularly. As of early 2022, over 200 DeFi projects have been listed on the DeFi Pulse website.
- Geographic diversity: DeFi adoption is not limited to any particular region or country, with users and projects located worldwide. However, regions such as the United States, Europe, and Asia have seen more significant adoption than others.
What Sets DeFi Apart from CeFi?
DeFi and CeFi are two different approaches to financial services. Here are some of the key differences between the two:
- Control: CeFi platforms are controlled by a central authority, such as a bank or financial institution, while DeFi platforms are built on decentralized networks that are controlled by their users. In CeFi, users rely on the central authority to manage their funds, while in DeFi, users have full control over their funds and interact with the platform through a decentralized network.
- Transparency: DeFi platforms are generally more transparent than CeFi platforms, as all transactions and data are stored on a public blockchain. This means anyone can view and audit the transactions on the platform. In CeFi, the central authority controls the data, and users may not have access to the same level of transparency.
- Accessibility: DeFi platforms are generally more accessible than CeFi platforms, as anyone with an internet connection can access them. In CeFi, users typically need to have a bank account or meet certain eligibility requirements to use the platform.
- Security: DeFi platforms are generally considered more secure than CeFi platforms, as they are built on a decentralized network that is more difficult to hack or attack. In CeFi, the central authority may be vulnerable to cyberattacks or fraud.
Overall, DeFi and CeFi represent two different approaches to financial services, with different strengths and weaknesses. DeFi is more decentralized, transparent, accessible, and cheaper, while CeFi is more established, user-friendly, and may offer more customer support.
Synergies Between DeFi vs CeFi
The DeFi market is still in its early phases. DeFi, like CeFi, offers several distinct characteristics, such as transparency, non-custody, and decentralization, thanks to the blockchain settlement layer. While it has several advantages, the blockchain restricts DeFi’s transaction speed, confirmation latency, and privacy. Despite this, DeFi continues to rely heavily on the traditional financial system. To summarize, the value of crypto assets on DeFi is still assessed and recognized primarily in fiat currency.
CeFi can help with this. CeFi lending personal information proof platforms provide a link between the existing financial system and the cryptocurrency asset market. What’s more, DeFi and CeFi are working toward the same goal. Both industries aim to serve customers with high-quality financial goods and services while also propelling the economy. In short, both DeFi and CeFi have advantages and disadvantages, and there is no straightforward solution to combine the best of both systems.
DeFi and CeFi Handshake
When comparing centralized to decentralized finance, the DeFi protocols not only replicate the core CeFi services; they also optimize them for the specific characteristics blockchains offer. In DeFi, for example, a new exchange mechanism known as automated market makers (AMM) has replaced CeFi’s popular order-book architecture. AMM, in a nutshell, is a smart contract that provides the service of acquiring assets from liquidity providers. As a result, rather than dealing with liquidity providers directly, traders trade against the AMM smart contract.
Learnings of DeFi and CeFi
CeFi and DeFi were both significantly stressed during the crashes. Centralized exchange systems were affected due to unusually high trade volume. Yet, unlike CeFi, DeFi services are technically always available due to the distributed nature of blockchains. DeFi solutions become too expensive for most consumers during extreme market circumstances due to the nature of the market. Since then, there has been an increased focus on the durability of DeFi protocols. Despite the fact that CeFi and DeFi have different settlement procedures and user behaviors, CeFi may learn a lot from DeFi’s stress tests.
Major Developments in Decentralized Finance in 2023
DeFi has been making a lot of noise lately, particularly following the FTX collapse. Some of the most popular DeFi coins have been:
- Kyber (a DEX)
What's the difference between CeFi and DeFi?
The primary distinction between centralized and decentralized finance is that one has a mediator in the form of KYC in place, whereas the other does not. Another significant distinction is that centralized finance offers customers less privacy than DeFi transactions.
Is Bitcoin a CeFi or DeFi?
Bitcoin is the definition of DeFi. Satoshi Nakamoto’s major pitch when introducing the Bitcoin whitepaper to the world was to provide a decentralized peer-to-peer transaction style to the banking world. Aside from that, when comparing centralized to decentralized financing, CeFi requires KYC verification; therefore, founders must be public.
Which is better, CeFi or DeFi?
Each option has merits and disadvantages. While CeFi offers fund security and fair exchange on those funds, DeFi aims to keep the space free of incursion. DeFi allows investors to implement their strategy without having to deal with an intermediary. Even though incidents such as FTX occur in the CeFi sector as a result of specific malpractices, DeFi continues to face a number of hurdles and challenges.
Both models have advantages and disadvantages. Which is the best option depends on the investor and their requirements. If you desire transparency and privacy, DeFi is the model for you. CeFi, on the other hand, should be chosen if trust, risk sharing, flexibility, and more investment possibilities are important to you.
COO & Co-founder
Written by Vitaliy Basiuk
COO & Co-founder at EvaCodes | Blockchain Enthusiast | Providing software development solutions in the blockchain industry