Bitcoin introduced the world to a whole new set of blockchain-based financial applications. CeFi (Centralized Finance) has been around since the time Bitcoin first emerged. However, a new trend has come into view in the form of DeFi (Decentralized Finance), which has garnered a lot of attention over the last year.
What is Decentralized Finance (DeFi)?
DeFi stands for Decentralized Finance, a blockchain-based form of finance that does not rely on central financial intermediaries to offer services. Instead, it utilizes smart contracts on blockchains. A smart contract is an automated code that runs on the blockchain and cannot be changed. Transactions happening in a smart contract are processed by the blockchain without any third-party intermediary.
There are several applications of DeFi. DeFi platforms allow people to lend or borrow funds, speculate on price movements using derivatives, trade cryptocurrencies, earn interest on funds, and more. For now, DeFi applications majorly revolve around the following functions: Providing peer-to-peer or pooled lending and borrowing platforms and enabling DEXs (Decentralized exchanges), Tokenization, and predictions markets.
What is Centralized Finance (CeFi)?
Centralized entities run CeFi services like centralized crypto exchanges. Most CeFi service providers tend to abide by regulations outlined by the local authorities where they operate. These regulations make it mandatory for centralized financial institutions such as exchanges and trading platforms to implement Know Your Customer (KYC) and Anti Money Laundering (AML) practices.
In CeFi, centralized companies and institutions store your funds in their custodial wallets. These crypto wallets store users’ private keys. In return, these services provide customers with different services. Cryptocurrency trading is currently one of the most common solutions enabled by centralized finance. In addition to trading, companies falling under CeFi provide their customers with services like borrowing, lending, margin trading, etc.
DeFi vs. traditional financial services
DeFi offers several benefits compared to traditional financial services. Using smart contracts and distributed systems, deploying a financial application or product is less complex and more secure. Overall, the DeFi movement is shifting traditional financial products to the open-source and decentralized world while facilitating financial freedom worldwide and removing the need for intermediaries, reducing overall costs, and significantly improving security.
CeFi vs DeFi
In terms of the financial services they offer, there are many similarities between CeFi and DeFi.
There are also significant differences to know between CeFi and DeFi.
In a centralized finance environment, exchanges or trading platforms are owned by a single entity or often a corporation. They provide a variety of services to make crypto more accessible to their customers. However, centralized exchanges are in charge of everything — right from onboarding users and setting up ground rules, among other things. DeFi applications, on the other hand, aim to decentralize ownership and become community-owned. Everybody has a say in how the application should function while its code
is run and maintained by the community.
In centralized finance, users must sign up and submit to KYC (Know Your Customer) regulations. It is often to prevent criminal activities like money laundering and abide by crypto regulations. In DeFi, as long as you have a non-custodial crypto wallet like MetaMask, you dont have to submit to KYC or sign up for an account.
In centralized finance, you have no other choice but trust exchanges and other centralized apps with your assets. In DeFi, you never have to trust anyone with your assets or if you want to trade them using a peer-to-peer swap or anything.
Learn more about the differences between centralized and decentralized exchanges.
To recap, although both CeFi and DeFi provide similar concepts, the approach is very different. The medium-term future is bright for both DeFi and CeFi, as the financial crisis will highlight the importance of refuge assets with low correlation to traditional markets. It will also stress the importance of blockchain solutions for all kinds of financial services that governments should not manipulate.