DeFi vs. CeFi: Understand the Differences
Centralized finance (CeFi) platforms resemble structured financial services, allowing users to borrow, borrow and earn interest on cryptocurrency holdings.
It is not easy to define how each cryptocurrency derives its value. Some say Bitcoin is worth its cost to mine, but in general a criptomoeda it's worth whatever can be sold for it.
Markets decide how much is worth a token through negotiation, where sellers raise the price to get better deals and buyers bid lower to make a profit.
The Ethereum network has a daily trading volume of over $25 billion, and with so much money at stake, matching bids and orders can become incredibly challenging.
Most cryptocurrency exchanges solve this by using a centralized platform to manage commercial orders, and while this works technically in light of the blockchain's core ethos — decentralization — it has its advantages.
What is Centralized Finance (CeFi)?
Centralized Finance (CeFi) platforms resemble structured financial services, allowing users to borrow, borrow and earn interest on cryptocurrency shares.
Although services are centralized, CeFi's goal is to make trading fairer, more efficient and more popular.
Furthermore, while most of CeFi's services rely on trusted third parties, they prioritize decentralization more than traditional financial services.
CeFi may represent stability and convenience, but high transaction fees due to intermediaries and a lack of transparency or absolute control over funds mean they don't appeal to everyone.
The cryptocurrency community values the ability to make transactions that no one can censor.
In a world where centralized exchanges can freeze funds or block withdrawals, people can migrate to alternative platforms.
What is Decentralized Finance (DeFi)?
Decentralized Finance (DeFi) are one of the most coveted slices of the blockchain industry today, but the idea itself has much more primal origins.
In fact, it's only been in the last two years that DeFi platforms have become practical. Where centralized exchanges use a central server to match offers and orders, decentralized exchanges have found it incredibly inefficient to use the same order book model in a distributed network.
Last year, the introduction of Automated Market Makers (AMMs) brought decentralized exchanges into the spotlight.
With AMMs, decentralized exchanges abandon the traditional order book model and replace it with pre-funded liquidity pools that consist of at least one pair of tokens.
Liquidity providers fund the pool with a reduction in trading fees based on the fraction of the liquidity pool they finance.
Privacy and KYC
Another important factor that drives users to DeFi platforms is privacy. Centralized exchanges and other CeFi services often require KYC disclosure complete, but while most DeFi platforms don't ask for personal information, they also don't have entry or exit ramps for fiat currencies.
Instead of trusting a corporation, DeFi requires users to trust a protocol.
While this prevents someone else from taking control of your funds, dealing with unaudited code in the blockchain space is always risky.
In just the past few years, the total ETH blocked on DeFi platforms has grown from almost nothing to over $50 billion today.
Today, CeFi platforms are most respected for their reliability and efficiency, but as DeFi continues to turn heads with their innovative, decentralized designs for financial applications, these platforms could threaten the dominance of some of the most prominent blockchain organizations.
#1 Main Difference: Trust and Accountability
DeFi platforms offer complete autonomy over funds, which means your assets belong only to you and no one else can touch them without your consent.
Compared to a regular international financial institution, DeFi also allows for faster and more affordable payments across international borders due to lower overhead costs.
There are more than 2 billion people around the world who do not have access to banking or financial services.
The technology Blockchain helps bring all kinds of money-related services to the most remote corners of the world, and with DeFi, virtually anyone with a smartphone can start buying, holding and using cryptocurrencies.
DeFi apps are also designed to work together, enabling some impressive and incredibly profitable ''yield farming'' cross-platform strategies.
Service providers are also kept impartial as data from DeFi platforms is publicly available.
However, despite the immense popularity of these platforms, policymakers are still unsure of how to regulate the space, which is almost certainly one of the most significant barriers to institutional adoption.
CeFi has incredible control over blockchain space, with the majority of cryptocurrency transactions taking place through CeFi's services.
These platforms require a password to login, but users are not given a private key to directly access their funds. Instead, the CeFi platform manages the funds for you.
The tokens available for trading are also centrally controlled and there are long and expensive processes for projects to get their tokens listed on the most popular CeFi platforms.
While key centralized services are generally secured with a single point of failure, attacks on these platforms can be devastating to their users.
In 2014, the Mt. Gox Bitcoin exchange was hacked and attackers stole over 850.000 BTC in user funds.
The exchange managed about 70% of Bitcoin transactions worldwide at the time, and even today, most users still haven't received any compensation for their losses.
CeFi is less focused on its users who own cryptocurrencies and more focused on letting them interact with the cryptoactive markets.
They also enforce platform-dependent rules that are subject to change at any time. DeFi, however, operates entirely on top of a decentralized infrastructure.
DeFi platforms use smart contracts to create a fair and transparent financial system that is more accessible to people around the world.
As an open source ecosystem, DeFi offers all kinds of services, with new ones being added continuously.
It also gives you full control over your assets, with no middlemen getting in the way of you and your funds.
While decentralized services are often marketed as 'untrusted', they do require a certain amount of trust in something, and the real difference between the DeFi and CeFi platforms is who their users choose to trust.
Where centralized platforms ask users to trust the company that runs the service, decentralized platforms ask users to trust their code, and that's a tough question for open source programming environments that handle billions of dollars in transactions.
CeFi platforms also often provide fiat currency entry and exit ramps, which require the company to store personal records and KYC information due to compliance requirements.
Confidential information in the hands of careless corporations can be dangerous, but it's often easier to trust a reputable brand than to take on self-care responsibilities.
Centralized exchanges have entire departments to ensure your data is handled correctly, including customer support channels and community engagement programs.
They also offer cross-chain services for currencies listed on independent blockchains like Bitcoin, Litecoin, XRP and more, allowing you to trade those currencies with ease.
DeFi systems are mostly built on the Ethereum network and while wrapped tokens are bringing more assets to the ecosystem, cross-chaining is not feasible at the moment.
DeFi services are supported by the community, for the community. They not only allow anyone to access their services without providing any information, but they also allow users to build on top of the decentralized network and collaborate with the community freely.
For this reason, DeFi products are often referred to as “money legos,” designed to benefit from and integrate with one another.
Also, while it's impossible to guarantee that a centralized service is reliable, code audited from a reputable source is theoretically much more secure, which makes DeFi apps a better choice for users who want something proven to be secure.
Development in the DeFi space is fast and the industry is progressively building more capable systems and experimenting with innovative ideas.
While there is still a long way to go, DeFi is slowly producing alternatives to every kind of centralized service available.
DeFi platforms are also slowly solving some of the smaller issues with space today, such as providing access to pooled assets.
Centralized services are at the heart of the blockchain movement against centralization, and while it may seem counterintuitive, they are critical to the continued growth of space.
In addition to taking responsibility for protecting your assets, these services also need to maintain performance levels, offering the best service at the lowest cost to maintain your user base.
DeFi platforms are more community oriented and are often bifurcated or built by platform members.
This allows for the creation of even more DeFi networks for users to interact with and facilitates growth to meet the real needs of the market.
For example, while Uniswap popularized AMMs, attracting people from all over the world to become liquidity providers (LPs), its code was forked to create the nearly identical SushiSwap, which differentiated itself mainly through better incentives for LPs , bringing users together and diverting liquidity from its mother platform.
DeFi is pushing the boundaries of what blockchains are capable of, but centralized services will always remain for those who prioritize performance and reliability.
Until decentralized systems can guarantee the same level of security and convenience for its users' assets, CeFi will continue to attract the largest number of cryptocurrency traders.
#2 Key Difference: Regulations and Market Size
Compared to DeFi, centralized platforms are much more established, having strengthened their brands in the decade since the creation of Bitcoin. DeFi is still a relatively young part of an industry that is just in its infancy.
While regulation is a growing issue in the blockchain space as a whole, centralized services are much luckier in getting regulatory approval, as there is someone to take responsibility for enforcing it.
Smart contracts can enforce regulation through codes, but poorly written applications can lead to substantial financial losses to the market.
Furthermore, as cryptocurrencies are still a very enthusiastic market, user experiences on DeFi platforms are relatively poor and the lack of customer support in decentralized networks may be what holds it back in the long run.
That said, decentralized networks have faced obstacles since the launch of the first cryptocurrency, and as more sophisticated applications begin to hit the market, this issue is likely to shrink over time.
However, another growing concern among community members is how centralized cryptocurrency exchanges have adopted similar operations as traditional banks.
This partly fuels the rise in popularity of DeFi platforms. While both types of services are essential in different ways, their future will depend on how well DeFi platforms can mimic the performance of their centralized counterparts.
CeFi services understand exactly what they want from their customers and try to push their user base in that direction.
DeFi platforms, on the other hand, are defined by how the community uses them, and this is an important distinction to make.
For new investors who are just dipping their toes in, centralized platforms are much more agile and easier to use, while their decentralized alternatives are designed more for experienced users.
CeFi provides stability and performance, while DeFi networks promote greater privacy and control over your assets.
While both ecosystems have a long way to go before cryptocurrencies see more widespread adoption, they are certainly on the right track.
With institutional adoption on the rise and DeFi protocols becoming increasingly advanced, DeFi could quickly become the dominant environment for all financial services.
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