The Crypto ecosystem comprises two main types one is decentralized finance, and another one is centralized finance. Both two ecosystem provides plenty of financial services and products. Old financial services such as lending, payment, and borrowing become accessible with the help of established banking institutions and other financial institutes. The overall financial system underwent a drastic transformation with the advent of blockchain technology. As the cryptocurrency concept widened, centralized finance and decentralized finance became the new considerations. The following guide will give a comparative study between centralized and decentralized finance. However, to know that comparison, you first have to gain a better understanding of what CeFi and DeFi concepts mean.
What do you mean by centralized finance or CeFi?
Before the introduction of decentralized finance, CeFi was the standard that facilitated crypto trading. It has a stronghold over the entire cryptocurrency industry. In the case of centralized finance, the central exchange helps in handling crypto trade orders. With the help of central exchange, funds can be easily managed, and no private keys are present to provide you the accessibility to a digital wallet. The central exchange will identify the type of points they will list for the purpose of crypto trading and how much fees you are required to pay to trade with the particular centralized exchange. In this centralized exchange, there is no need to own any cryptocurrency for buying or selling purposes. You must follow the rules and regulations imposed on you by the centralized exchange.
What do you mean by decentralized finance or DeFi?
There is no exchange present in the case of decentralized finance. The entire process is managed and operated with the help of automated applications built on blockchain platforms. Decentralized finance helps develop a transparent and fair financial system so everyone can participate smoothly. No central body or authority is present in the case of decentralized finance, enabling unbanked individuals to access banking and financial services with the help of blockchain technology. The main decentralized finance is developing a permissionless, open-source, transparent, and quick financial service environment. A decentralized financial ecosystem provides various services such as yield farming, borrowing, asset storage, crypto lending, and other services. The main benefit of decentralized finance over centralized finance is that individuals can have full control over their assets and have their key pair for their digital wallet. Users must utilize dApps or decentralized applications to participate in the DeFi ecosystem. These applications are built on blockchain platforms that DeFi services can easily access.
CeFi vs. DeFi
There are several differences between CeFi and DeFi, and the main question in users’ minds is which one they should trust to get the best service. With the help of decentralized finance, users can trust technology that will perform financial services and execute them as they want. On the other hand, in the case of centralized finance, users have to trust people who manages their funds and resources and execute financial service. Both CeFi and DeFi provide several varieties of cryptocurrency-associated financial services.
Some of the important functionalities and features of both DeFi and CeFi ecosystem which differs from one another are as follows:
What are the features of centralized finance or CFI?
Centralized Exchange (CEX)
With the help of traditional cryptocurrency exchanges such as Coinbase or Binance, users can easily send funds. These funds are stored on the cryptocurrency exchange and kept outside users’ custody, so they are at high risk of vulnerabilities to security threats in case the privacy and security measures fail. This is why centralized exchanges have maximum cases for security attacks and malicious threats. Customers on centralized exchanges share their personal information and put funds into the company’s custody since they consider these exchanges trustworthy and reliable. However, many such exchanges have a department with a client service team that provides customer support. This helps strengthen trust and reliability, and customers know their funds are safe.
The flexibility of turning Fiat into any cryptocurrency
There is a high level of flexibility in centralized services compared to decentralized services since it provides the flexibility of Fiat conversion. A centralized entity or authority has to be present to convert Fiat currency into cryptocurrency and vice versa. Onboarding customers have found a centralized finance ecosystem to offer a better customer experience and convenience.
Cross-chain services
Trading of BTC, XRP, and LTC, along with tokens that are issued on different blockchain platforms, are well supported by centralized finance. DeFi services suffer from drawbacks such as complexity and latency. As a result, performing cross-chain services with the help of tokens is not supported by DEFI services.
Centralized finance can easily overcome this setback as the custody of funds is received from different chains.
What are the features of decentralized finance?
Permissionless
There is no requirement for obtaining permission from users to use DeFi services.
This is not the case with centralized finance as they have to complete the KYC procedure for accessing the financial service, and they also have to share their details and information or even deposit a certain amount of time before availing of the services. However, in the case of decentralized finance, users can access the financial service directly with the help of a wallet without providing personal information or depositing funds with the DeFi ecosystem. This is because decentralized finance is accessible openly to all parties without discrimination or barriers. Users who want to build on a decentralized platform can access services freely. This decentralized finance offers accessibility and collaboration. DeFi products developed within the ecosystem also provide many benefits, which is why these products are also referred to as money legos.
Trustless
The main benefit of accessing the deFi service is that you need not install your trust that the promoted service will be performed accordingly. You can easily authenticate that the decentralized financial services will perform as they are intended to with the help of external tools like etherscan (ethereum ecosystem) or by auditing the code to identify whether the transaction has been executed correctly.
Quick Innovation
An important advantage of decentralized finance is that it helps to promote rapid innovation. A decentralized finance ecosystem helps to build current capabilities and even experiment with new service capabilities. DeFi space is built-centric in nature, which is why groundbreaking financial services are embedded into this rich ecosystem. Several functionalities wherein centralized finance services have successfully thrived in the decentralized financial ecosystem have proved to be the best alternative to solve the challenges CeFi has brought. Several solutions, such as WTC and tBTC, have come up to overcome the inability of DeFi to help in the transfer of incompatible cryptocurrencies like BTC. These solutions are compatible with other decentralized protocols and help eliminate the gap.
CeFi vs. DeFi
Centralized finance is similar to TradFi or traditional finance since users have to deal with trusted intermediaries. Although there are many similarities between traditional finance and centralized finance, both are not the same as traditional finance or legacy institutions venture into the digital asset ecosystems, whereas centralized finance is the digital asset companies that provide crypto-related services and products. CeFi platforms include crypto lending companies, centralized crypto exchanges, digital currency payment providers, etc. Users have to abide by the rules which these CeFi companies make. If you are a crypto beginner, then CFI will be an easy point of entry for you.
DeFi system removes the intermediaries and includes smart contract protocols. This system provides more decentralization to the world of financial services and products. Treating of peer-to-peer financial services and products is enabled with the help of DEFI. Such products and services are offered with the help of decentralized applications built on top blockchains like avalanche, Solana, Ethereum, etc.
- Regulatory compliance
While CeFi requires users to abide by the KYC regulations within the country where it operates, along with other requirements related to anti-money laundering and combating terrorism within the financial system. However decentralized financial system remains largely unregulated and is free from regulatory compliance.
- KYC requirement
Users of the CeFi ecosystem have to provide their data and information via the KYC process, which gives them accessibility to CeFi platforms, whereas DeFi users are not required to undergo any KYC process.
- Third party reliance
Users depend largely on third parties to access financial services and products in centralized finance. On the other hand, users of DeFi ecosystems need not be dependent on 3rd party reliance for accessing financial services and products.
- On ramps
On ramps of CeFi are crypto to crypto and fiat to crypto; however, DeFi enables only crypto to crypto on-ramps feature.
- custody
CeFi users aren’t in control of the crypto assets that they own. DeFi users, on the other hand, control their crypto assets, and therefore they have to be highly cautious and responsible to keep their crypto assets safe.
- Transparency
CeFi platforms maintain their system of chain and take all the decisions behind closed doors; therefore, they do not reveal their practices and processes related to trading and price formulation. They do not store any transactions on the blockchain network. On the other hand, DeFi platforms record all the transactions on the blockchain and make them visible to the users.
- Security
CeFi platforms are highly vulnerable to privacy and security breaches. Compared to CeFi platforms, DeFi platforms are more secure. As operations run on code on DeFi protocols, users can interact with the protocols with the help of non-custodial wallets.
CeFi vs DeFi: Pros & Cons
- CeFi
Pros
CeFi platforms function like traditional financial service providers, so people find them easy to use and familiar. These platforms also support Fiat to crypto exchange. Buying crypto is easy on a centralized crypto exchange if you buy it with your local currency. Centralized crypto exchange support Fiat currency based on the country.
Cons
Users must share personal information like residential addresses, selfie pictures, national identity details, etc. CeFi is also not accessible to all, as this platform has location restrictions. For example, some CeFi exchanges will not allow people that are in the blacklisted countries to perform trade on their platform. This makes this platform restrictive. Also, CeFi company makes all the decisions behind closed doors, and users don’t know their trading practices. This makes them less transparent.
- DeFi
Pros
As long as you have a stable Internet connection and a wallet, you can easily use DeFi products, and the DeFi platform is permissionless and comes without any restrictions. The transaction takes place on a blockchain network; therefore, they are more transparent and can be viewed easily. DeFi users also enjoy privacy as this platform does not require them to store or seek any personal information from users.
Cons
DeFi protocols depend on the blockchain they are built on, which may cause scalability issues. As DeFi protocols are unconventional and new, beginners find it difficult to understand the platform. It may take some time for users to understand the deFi platform and the products they offer before beginning to interact with them.
Conclusion
Both decentralized finance and centralized finance help in achieving similar goals. Both want to make crypto trading popular, strengthen the trading volume, and improve the financial service. The only difference between the two finance systems is how they carry out their goals.
Centralized finance promises the safety and security of funds and promotes free trade on such funds. Users or investors having conventional currency can participate in crypto trading. CEFI exchanges also offer good customer support services in places where decentralized finance services cannot offer. Decentralized finance, on the other hand, aims to make the finance space intrusion free. This ecosystem helps investors to freely implement their goals and strategies without dealing directly with an intermediary body. Both CeFi and DeFi models have their advantages and disadvantages. It depends entirely on the needs and requirements of the investor about the type of model that he or she wants to opt for. For example, decentralized finance would be the right model for you to choose from the two options if you prefer privacy and transparency. On the other hand, if your main criteria and priority are sharing the risk, trust, increased flexibility, and more options for investing, then centralized finance would be the right model for you.