Decentralization is one of the most important concepts in the crypto industry. DeFi (decentralized economy) is a new financial system that does not depend on a central party. It is a complete digital ecosystem with smart contracts that enable financial services like borrowing, saving, trading, etc. without intermediaries.
However, DeFi is still in its infancy. Navigating DeFi requires a lot of technical knowledge and expertise, with the potential to lose all or part of your investment due to bad programming, malicious hackers, or even simple user error. This is why many crypto users take into account CeFi as well, even though it’s a much less talked about technology. This article takes an approach on the main differences (and possibly similarities) of DeFi and CeFi.
A deep dive into DeFi
Decentralized finance eliminates intermediaries allowing individuals, traders and companies to carry out financial transactions using new technologies. Through peer-to-peer networks, DeFi uses security protocols, connections, software and hardware advances.
Provided they have an Internet connection, individuals can borrow, trade and lend by using software that records and monitors financial activity based on decentralized financial databases. A distributed database is available because it collects and aggregates data from all users and uses a consensus mechanism to verify it.
DeFi completely eliminates the need for a centralized economic model because everyone can access financial services anywhere, no matter who or where they are. DeFi apps give users more control over their money through personal wallets and trading services.
Decentralized finance functions based on blockchain technology, which is also used by cryptocurrencies. Blockchain is a decentralized and secure database or ledger. Applications called dApps are used to process transactions and run the blockchain.
In a blockchain, transactions are recorded in blocks that are verified by other users. When the verifiers accept the transaction, the block is closed and encrypted; another block is created with the data from the previous block. Blocks are “chained” in advance of each block’s data, giving it the name blockchain.
One of the main drivers behind DeFi is P2P (Peer-to-Peer) financial transactions. In a P2P DeFi transaction, two parties agree to exchange cryptocurrencies for goods or services without the involvement of a third party. In DeFi, P2P can meet a person’s loan needs and an algorithm will match the lender’s terms with suitable partners and the loan will be granted. P2P payments are made through a decentralized application or dApp and follow the same process on the blockchain.
Here are some benefits of DeFi:
- DeFi is permissionless and inclusive. DeFi services are available to anyone with a cryptocurrency wallet and an internet connection, regardless of location. Users can also do business and transfer their assets wherever they want without having to wait for bank transfers or pay normal bank fees. (Although other crypto-specific fees may apply, such as gas fees.)
- Transfers happen in real time. The blockchain is updated after a transaction is completed and the interest rates are updated several times a minute.
- Transactions are transparent. Every transaction on the Ethereum blockchain, which accounts for more than 90% of all DeFi traffic, is sent and confirmed by other network users. This level of transaction data transparency ensures that any user can see network activity.
- Users can store their assets using untethered wallets or through smart contract maintenance.
What is CeFi and its main benefits?
CeFi (centralized finance) is a technology where users can borrow, earn interest, and buy and sell cryptocurrencies through a centralized facility. This is usually a centralized exchange (CEX), but it can also be institutions that offer cryptocurrency earnings to users.
The goal is to make financial services as efficient and profitable as possible while maintaining a fair exchange during crypto transactions. CeFi allows users to borrow money, exchange cryptocurrencies, use a crypto debit card to make purchases, receive rewards and more.
The main difference between CeFi and DeFi is the buying and selling process. CeFi uses centralized entities to monitor the system. However, DeFi relies on blockchain technology. Prominent CeFi exchanges like Binance and Coinbase have been offering crypto services for years, while decentralized exchanges (DEX) run on blockchains like Ethereum (ETH).
As CEXs participate in CeFi, they are responsible for securing users’ funds. The user’s risk is in the exchange, while DeFi removes these middlemen. Instead, two parties buy and sell cryptocurrencies using smart contracts, which are digital contracts that are automatically activated when predetermined conditions are met.
CeFi facilitates fiat and cross-chain solutions for cryptocurrency transfers. If necessary, CeFi funds can be transferred to assist customers or suspend transactions in the event of an event such as a cyber attack. CeFi can restrict users and block transactions, while DeFi cannot. DeFi is considered more open and sophisticated, as there are fewer barriers to market entry and all terms are completely transparent. Instead, users create cryptocurrency wallets with public and private keys that allow them to trade crypto anonymously.
Here is a list of the benefits of Cef and the benefits it offers:
- User Experience: Interaction with centralized settings is similar to what users know already. Transactions happen faster and user interfaces can be much simpler and require less technical knowledge.
- Fiat-to-Crypto Conversions: CeFi offers the most comprehensive cryptocurrency-to-fiat-to-crypto conversions. These services contribute to the growth of cryptocurrencies by allowing individual and institutional investors to inject significant capital into the market, providing sufficient liquidity to top-tier cryptocurrencies such as bitcoin (BTC) and ether (ETH).
- Cross-Chain Exchanges: CEXs facilitate the conversion of cryptocurrencies from one blockchain to another, as individuals often do not own the cryptocurrency, and transactions are represented in a SQL database.
- Customer support: DeFi runs on a blockchain with smart contracts. In the event of fraud, such as a theft or cyber attack, users will not be able to notify any supervisory or regulatory authority. CeFi CEX banks, on the other hand, operate like regular banks and offer 24/7 service. CEXs are responsible for their cryptocurrencies and can request their help if something goes wrong.
CeFi and DeFi are relatively new financial terms in the crypto world. DeFi aims to democratize finance and put power back in the hands of the people, while CeFi aims to improve the areas where DeFi fails. Both have their pros and cons – the biggest criticism of CeFi is the lack of transparency, accountability and anonymity. But many new crypto options take these factors into account when offering digital financial services.
