Payments, loans, and borrowing were traditionally only available through established financial institutions including banks. However, when blockchain technology arrived, everything changed. Cryptocurrency is no longer a term that only a few people are familiar with. These days, not only many businesses are interested in the bitcoin market but also a big number of individual investors. With the popularity of cryptocurrencies growing, the conversation has switched to a new set of topic: CeFi (centralized finance) and DeFi (decentralized finance). The creation of an entire market focused on digital currency and blockchain technology was driven by Bitcoin. Decentralized solutions, according to certain cryptocurrency market participants, will eventually replace all traditional financial services. Although it's too early to be making such statements with certainty. We can all agree that the evolution of money is a fascinating and the competition between centralized finance (CeFi) and decentralized finance (DeFi) is taking place. In this article, a detailed introduction, their differences, and their similarities will be discussed. So let’s dive in…
What Is Decentralized Finance (DeFi)?
Decentralized finance (DeFi) previously called “open finance” is a new financial system based on distributed ledgers that are identical to those that are used by cryptocurrencies. It simply takes out the intermediaries from your financial transactions. Money, financial services, and financial products are no longer under the jurisdiction of banks and institutions in this technology. Before going into the details, you should first get a concept of decentralization.
Decentralization
In the blockchain, The movement of decision-making and control from a centralized entity (person, organization, or group) to a dispersed network is referred to as decentralization. Decentralized networks aim to limit the amount of trust that participants put in one another and to prevent them from imposing power or control over each other in ways that harm the network's performance.
Some key attributes of DeFi for many users are:
- It rids the fees charged by banks and many other financial institutions for using their services.
- Instead of depositing your money in a bank, you keep it in a safe digital wallet.
- It can be used by anyone with just an internet connection without needing any permission.
- You can move funds in a matter of seconds or minutes.
- there's a degree of transparency as the code can be reviewed by anyone.
- There are public networks that cross geographical boundaries.
By allowing individuals, merchants, and corporations to perform financial transactions using evolving technologies, decentralized finance excludes intermediaries. Peer-to-peer financial systems that use connectivity, software, security protocols, and hardware developments have been used to accomplish this. Stablecoins, hardware, and software that facilitate the development of applications are all elements of DeFi. The DeFi infrastructure, as well as its regulation, is still in the debate and construction.
You can trade, borrow and lend by using software that tracks and validates financial transactions in global financial databases from almost anywhere you have a stable internet connection. A distributed or global database is accessible from multiple locations; it gathers and analyzes data from all users and verifies it with the help of a consensus process. Decentralized finance uses this technique to abolish centralized finance models by allowing anybody, irrespective of who or where they are, to access financial services.
How does DeFi work?
DeFi is mainly built on Ethereum, which is the 2nd most famous cryptocurrency after Bitcoin. you can engage with DeFi through software known as dapps (“decentralized apps”), the majority of which are based mainly on the Ethereum blockchain. There is almost no need to fill any application or open an account, unlike a traditional bank.
Though DeFi is widely recognized in reference to cryptocurrencies, it goes beyond the creation of new digital money or value. DeFi's smart contracts are designed to take the position of conventional financial systems. It's all about the code in DeFi. Your currency is programmed to fulfill numerous [functions] with the use of smart contracts. It provides a once-in-a-lifetime chance for anyone with access to a computer and the internet to take part in the global economy.
For most of these financial activities, one of the most appealing aspects of DeFi is that it removes the barrier to entry. You don't get to have your money managed by the government or a company, and you don't have to meet particular criteria to get certain financial goods.
You apply for a loan by using traditional financial procedures and may be denied depending on your credit. You do have a brokerage account or a bank account with a company that manages your funds.
By using DeFi's smart contracts, financial transactions are carried out if specific requirements are met. Lending, Borrowing, and other transactions are all possible with smart contracts, and the conditions of the transaction are practically encoded in the code. Since this makes certain transactions more user-friendly and effective, it also can make them more prone to errors that are unable to be fixed.
Here are a few ways people are interacting with DeFi:
- Lending: Rather than earning interest and incentives once a month, lend out your cryptocurrency and get rewards and interest every minute.
- Receiving a loan: Instantly obtain a loan without the need to submit any paperwork, even super short-term “flash loans” that other traditional financial institutions can not provide.
- Trading: Do crypto asset trades peer-to-peer as if you were selling and buying stocks without using any broker service.
- Saving for the future: Invest part of your cryptocurrency in alternative savings accounts to earn higher interest rates than you'll ever obtain from a bank.
- Purchasing derivatives: place short or long bets on specific assets. Consider them the cryptocurrency analogue of stock options or futures contracts.
Centralized Finance (CeFi):
CeFi combines some of the yield advantages of DeFi with some of the ease of use and security of traditional financial services products. With CeFi, you can earn interest on your savings, borrow money, spend money with a cryptocurrency debit card, and more.
The network then clears the amount and requests your bank for payment. Your bank confirms the payment and transmits it to the network, which then delivers it back to the retailer via the issuing bank. Each element in the chain takes the price for its services, mostly because merchants should pay for your capability to use debit/credit cards.
All the other financial activities charge money; loan applications might take days to process, and you may not be allowed to use banking services while traveling.
The basic motive of both Centralized Finance (CeFi) platforms and Decentralized Finance (DeFi) platforms remains the same i.e. to enable consumers to use cryptocurrencies for almost all of their financial requirements and services. However, the manner in which they carry out their tasks differs.
How does CeFi work?
CeFi allows users to earn money through crypto-based banking accounts that are mainly identical to traditional bank savings accounts but it may yield much higher rewards.
Unlike regular savings accounts, not all crypto deposits are yet protected by insurance, so users should be cautious. The basic concept is to keep a portion of your cryptocurrency on one of the many sites that offer this service.
The term “centralization” refers to the concentration of an organization's management and decision-making processes under a single authority or location. The head office maintains decision-making authority in a centralized organization, whereas all subordinate offices take information from the main office. The leaders and experts who make critical decisions are housed in the corporate headquarters.
In centralized finance, all crypto trading transactions are channeled through a central exchange (CeFi). People in charge of the exchange are in charge of the money. This means that if you don't have a secret key, you won't be able to access your wallet. The exchange also decides which cryptocurrencies are available for the trading purpose and how much users should pay in fees to utilize their platform.
DeFi pros and cons:
The encouraging aspects of DeFi discussions suggest thorough observation of the pros and cons of DeFi.With each passing day, the market demand for decentralized finance (DeFi) is getting strong. The DeFi movement seeks to offer customers and investors various benefits. Therefore, getting a detailed view of DeFi's benefits and drawbacks is important for properly estimating its potential. Here are some notable pros and cons of DeFi:
DeFi Pros:
- Open: You do not need to “open” an account or apply for anything. You just need to make a wallet to get access.
- Pseudonymous: You are not required to give your name, contact number, email id, or any other personal data.
- Fast: Rewards and interest rates are frequently updated (as often as every 15 seconds), and they might be much higher than those on traditional Wall Street.
- Flexible: You can shift your assets anytime at anywhere without obtaining authorization, waiting for lengthy transfers to complete, or paying high costs.
- Transparent: The entire set of transactions is visible to everyone engaged (private companies rarely grant this type of transparency).
DeFi Cons:
- Due to variable transaction rates, active trading on the network of Ethereum may become pricey.
- Because this is a novel technology, your investment could see significant volatility depending on which dapps you use and how you use them.
- You should keep your proper records for tax purposes. Regulations vary depending on where you are.
- Since there is no regulatory authority, you potentially lose your valuable assets if you forget your password.
- The DeFi upstarts frequently claim to be open to all. Without typical financial credentials like identity or a credit score, you might be able to secure a loan or trade virtual currency. That independence has the potential to bring financial services to sections of the world that haven't previously had them, or where they are too expensive or vulnerable to fraud. However, the disadvantage is obvious: if no one is keeping track of who is utilizing a system or where they are situated, the services could be exploited by criminals or run contrary to government regulations. The crackdown on regulations has already begun.
CeFi pros and cons:
CeFi works by establishing trust along the way. Unlike DeFi It guarantees the safety of funds and the fair trading of those funds. CeFi intends to make trading, fair, improve transaction processing, and speed up selling and buying processes. However, it has its own benefits and risks that you should know before investing in CeFi. Below are some pros and cons of CeFi:
CeFi pros:
- Because of their history and reputation, CeFi platforms have been able to provide highly intuitive and efficient user experiences.
- They are able to provide a broader range of traditional financial services, such as direct fiat currency support. This is one of the reasons why CeFi platforms continue to outnumber DeFi platforms by a significant margin.
- CeFi provides custodial solutions to help new users manage seed phrases and keep their keys and addresses safe.
CeFi Cons:
- Every CeFi product and its provider is different, and your deposited crypto may be used in ways that are more or less risky. It's essential to conduct your research and understand how your cryptocurrency is being
- It's essential to conduct your research and understand how your cryptocurrency is being
- Remember that crypto deposits are not currently covered by the government insurance that protects traditional bank savings.
- Some CeFi providers may put your principal on hold for a while. Some other providers, on the other hand, may allow users to access your USDC anytime.
- Stablecoins aren't all the same. USDC, for example, is built on open-source software that anybody can examine. USDC is secured by dollar-denominated assets in separated accounts with the United States regulated financial institutions that are at least equal to fair market value to the USDC in circulation. USDC can be purchased from different CeFi trading exchanges and stored in any Ethereum compliant wallet. There are no costs associated with converting a US dollar to USDC.
The current state of the ecosystem:
CeFi platforms dominate the DeFi ecosystem in terms of total market size and number of users. CeFi platforms are significantly more well-established than DeFi platforms. Centralized loan platforms and cryptocurrency exchanges have taken years to build open delivery services and user interfaces that DeFi platforms are still catching up to.
However, a rising number of investors believe that centralized crypto exchanges function like traditional banks, and decentralized exchanges have risen in popularity as a result. Defi’s market value reached the highest of 100 billion dollars in October 2021, then fluctuated and now in January 2022, the market value of DeFi is 80 billion dollars.
In May 2021, the size of the decentralized finance (DeFi) market, as measured by the ratio of cryptocurrency locked, dropped by almost $25 billion USD in a single week. This could've been prompted in part by huge price changes in roughly 100 different cryptocurrencies that may have forced investors to flee. Another reason is the increasing gas prices (transaction fees) for Ethereum, the most commonly used cryptocurrency in DeFi. Experts have seen that when the crypto market falls, there is a demand for alternative blockchain systems that are not based on Ethereum.
DeFi as an innovative alternative to CeFi:
DeFi protocols don't just copy standard CeFi services, but also customize them to the specific characteristics of blockchains. For example, in DeFi, a new exchange system called AMM (Automated market maker) has replaced CeFi's famous order-book structure.
AMM is the Smart Contract that deprives liquidity providers of their assets. As an outcome, instead of dealing directly with the liquidity providers, traders trade with the AMM smart contract. Transaction costs are lower with the AMM architecture than with a CeFi order book because there are fewer interactions with market makers.
CeFi, on the other hand, is adopting these developments. Centralized exchanges (such as Binance) has started to provide business services after the AMM idea was introduced. Certain CeFi markets, like foreign exchange, that have combined the AMM model with human interaction are well-prepared to reach the DeFi market-making sector, whereas existing DeFi marketplaces are not. AMM providers may use some CeFi measures to reduce their customers' exposure to intermediaries.
How DeFi differ from CeFi in various properties?
In the section below, the most common DeFi vs CeFi features are explained.
- Public Verifiability
Whilst DeFi application code may or may not be accessible, the bytecode and execution must be publicly verifiable on the blockchain in order to be categorized as non-custodial DeFi. As a consequence, unlike CeFi, each DeFi user may monitor and verify that DeFi state changes are carried out on time Because of this transparency, the innovative DeFi technology has an unmatched ability to transmit trust.
- Atomicity
A blockchain transaction enables the execution of a series of actions, which could include multiple financial transactions. The combination could be made atomic, which means that the transaction would either perform all of its actions or fail all of them at the same time. While CeFi lacks this programmable atomicity trait, expensive and time-consuming legal agreements could be utilized to ensure atomicity.
- Anonymous development and Implementation
You may have less anonymity with centralized finance than with DeFi transactions. Many DeFi programs are founded and maintained by anonymous teams, and the founder of Bitcoin is still unknown. Once the DeFi smart contracts get deployed, the miners operate them implicitly. Without a front-end, anonymous DeFi applications can operate, forcing you to directly interact with the smart contract.
- Custody
DeFi, unlike CeFi, allows clients to control their assets directly at any moment (you don't need to wait for your bank to open). Nonetheless, great power comes with great responsibility. until any insurance is written Users bear the majority of technical risks. therefore, centralized exchanges, which are similar to traditional custodians, are famous for keeping your cryptocurrency assets.
- Trading of crypto assets
CEXs are based on the same principles as their conventional equivalents. CEXs keep limit order books, which are off-chain records of the magnificent orders posted by dealers. On the other hand, Decentralized exchanges (DEXs), work in a fundamentally different way, by using AMM (automated market-maker) protocols to match the counterparties in a deal. AMMs use mathematical algorithms to determine prices based on transaction volumes.
- Execution order malleability
Permissionless blockchain users often openly discuss the transactions they want to perform over a peer-to-peer connection. for example, you can engage in transaction fee bidding contests to drive the transaction execution order as there is no permanent centralized entity directing transaction execution. Many market manipulation strategies have been presented as a consequence of this order malleability, which is now commonly used in blockchains.
Regulatory agencies in CeFi, on the other hand, impose strict rules on financial services and institutions like how transaction ordering should implement. Due to the centralized nature of the financial intermediaries of CeFi, this is possible.
- Costs of transactions
For minimizing spam, transaction fees in DeFi, along with blockchains in general, are crucial. Financial institutions in CeFi, on the other hand, can always choose to provide transaction services for free because they can rely on AML (anti-money laundering) verifications of their customers (or are bound by government regulations and rules to provide some financial services for free).
- Non-stop market hours
CeFi marketplaces are known for their frequent outages. For example, The Nasdaq Stock Exchange and The New York Stock Exchange are the two most important trading platforms in the United States, with hours of operation ranging from 9:30 a.m. to 4:00 p.m. EST (Eastern Time) from Monday to Friday.
Most of the DeFi markets, if not all of them, are open 24/7 due to the non-stop nature of the blockchains. As a consequence, DeFi has no pre- and post-market trading, but CeFi has thin liquidity on a range of items during these times.
- Privacy
Only blockchains with non-privacy-preserving smart contracts support DeFi. As a result, rather than providing actual anonymity, these blockchains give pseudo-anonymity.
Because centralized exchanges with anti-money laundering regulations are frequently the only suitable option for changing money into cryptocurrency assets, these organizations have the authority to disclose address ownership to law authorities.
- Arbitrage concerns
To avoid price swings, an arbitrage should preferentially operate atomically. Arbitrage on hybrid and fully centralized exchanges are fundamentally subject to market price volatility unless arbitrageurs collaborate with exchanges to ensure execution atomicity.
Arbitrage among two decentralized exchanges within the same blockchain can be considered risk-free if transaction fees are omitted. This is due to the atomicity of the blockchain, which allows traders to create a smart contract that executes the arbitrage and falls back if the arbitrage doesn't really yield any profit. When 2 DEXs on different blockchains are arbitraged, the risk is comparable to hybrid and CEX exchange.
- Inflation
Inflation is defined as the decline of a current currency supply due to the addition of a new currency supply. Although inflation is described as a loss of a currency's buying power, the connection between inflation and supply is not always evident; the money supply can sometimes grow without causing inflation. Central banks retain the capacity to generate fiat money in CeFi, and inflation is frequently measured against the worth of a sample basket of consumer goods, referred to as the consumer price index.
The asset supply of numerous cryptocurrencies is likely to alter in the DeFi world. Bitcoin (BTC) will very certainly face a situation in which supply has a strict limit but the economic activity it must support does not have any cap- leading to a shortage of currency. Furthermore, without a bonus therefore no inflation, Bitcoin, or the blockchains in general, may be exposed to security flaws. It's unclear whether BTC as well as other cryptocurrencies face severe income disparities because of the inflation of the fiat system. There is still no evidence that cryptocurrency will solve this issue.
- Cross-chain services:
CeFi services are frequently used to trade Bitcoin and other significant coins developed on independent blockchains. Due to the difficulty and time required to complete atomic cross-chain trades, DeFi services typically do not accept these tokens.
CeFi's services address this issue by keeping funds from multiple chains (whereas decentralized services require that tokens follow the token standards of Ethereum to attain interoperability). This is a huge advantage for CeFi because many highest-market-cap and also most frequently traded coins operate on other blockchains and do not follow interoperability standards.
- Flexibility in Fiat conversion
Centralized services are typically more flexible than decentralized ones when it comes to transferring money to Bitcoin and likewise. Most DeFi operators do not give fiat on-ramps since the conversion of fiat to cryptocurrency needs a centralized institution. Customers could also be hired faster in CeFi, which contributes to a good customer experience.
- Liquidity: An intersection of CeFi and DeFi
The main feature of DeFi and CeFi services is that they have the ability to give consumers the liquidity they require to facilitate transactions at a fair cost.
Unfortunately, many bitcoin assets have limited liquidity, and DeFi and CeFi are still trying to solve this problem. Maybe there's no current transaction order in the marketplace that fulfills your order parameters when you submit a transaction. Furthermore, CeFi and DeFi's liquidity is dispersed among numerous exchanges.
Professional blockchain R&D (research and development), as well as white papers, wallets, exchanges, official websites, promotion, and packaging, are available.
- Similarities between both financial institutions:
CeFi and DeFi have some similarities such as they both involve financial services. In some cases, The end-user may not even realize whether a crypto service uses CeFi or DeFi infrastructure. Both CeFi and DeFi currently support the same set of financial services, such as spot trading, margin trading, derivatives trading, borrowing and lending, stablecoin production, and payments.
When it comes to trading, both DeFi and CeFi systems can offer user-friendly interfaces that allow newcomers to get started quickly. The establishment of both CeFi and DeFi programs frequently involves the same persons and organizations. Both approaches, after all, promote the usage of digital currency and blockchain.
- Future expectations:
Both DeFi and CeFi have a promising near future since the financial crisis will emphasize the need for refuge assets with minimal connection to conventional markets. It will also highlight the significance of blockchain solutions for all types of financial services that should not be manipulated by governments.
DeFi will prosper in the long run because it has the ability to make financial services available to everyone. Investors must keep a close eye on Ethereum's shift to the regulatory changes and Proof of Stake and around DeFi, both of which will have an impact on the developing sector.
Top CeFi Platforms with DeFi products
We covered below the top CeFi exchanges and services of DeFi from all around the world.
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Final Words
In conclusion, you may notice the distinct pointers in the debate of DeFi and CeFi. Despite all of the contrasts between DeFi and CeFi. DeFi has a significant advantage over CeFi in several areas. However, it lacks the ability to provide cross-chain services.
With the exception of some drawbacks, DeFi offers a clear and viable alternative to CeFi offering greater control over financial assets. The most essential aspect of DeFi is that it has the ability to make financial services more accessible to the general people.
