The emergence of cryptocurrencies and blockchain technology at large has led to even more innovation. This development was the stepping stone to Decentralised Finance (DeFi) and Centralised Finance (CeFi). While both concepts have tremendously helped the ecosystem, they differ in some ways, especially when it comes to investors and overall protection. Investor protection is emphasised by different financial institutions, which aims to prevent counterparty risks and fraudulent activity.
Because of this, investors are usually torn between choosing a CeFi platform or sticking with DeFi.
Do you wonder what makes DeFi and CeFi different? Then, read this article to the end and find out what makes these concepts different. And if you wish to extend your knowledge further, feel free
Financial institutions have been threatened by the disclosure of technology that acts as an alternative code for trust. Hence, investors and traders seem to have turned to permissionless environments for trading. This system of public blockchains is letting anyone participate in transactions such as buying and selling instead of having to trade with an uneven power of a huge institution. This summarises the idea of the DeFi system.
Centralised finance, on the other hand, is focused on standardisation. In addition, the ease of trade is an effect that gives it an edge over DeFi. Furthermore, since blockchain technology is all about trust, having a system of financial products developed on top of decentralised and open-source blockchains is nothing but exceptional, thanks to DeFi.
However, these short definitions might not do justice to what DeFi or CeFi entails. So, first, let’s assess what Decentralised Finance means.
What Is Decentralised Finance (DeFi)?
As the name implies, ‘decentralised’ means no central authority exists. So, you can define Decentralised Finance as a process that involves digital asset transactions without the involvement of a third party. So, in this case, transactions take place between two parties and they do not need an intermediary to play any role.
You can say DeFi is permissionless, thanks to blockchain technology. However, you may be wondering how the transactions would be possible without both parties or either of them cheating each other. This doubt is solved by smart contracts. So, instead of an institution, smart contracts automatically play the role without any partial sentiment since it is automated.
Interestingly, this does not mean that the role DeFi plays means that it won’t be able to offer services provided by traditional financial institutions or centralised platforms. In fact, DeFi offers services including lending, borrowing, loans, and asset storage.
However, it differentiates itself from the “norm” due to the smart contracts system. As a DeFi user, you can hold your assets with private keys that only you have access to, and you can be anonymous as long as you want, only recognised by that wallet or address you use. Some examples of DeFi platforms include DEXs such as PancakeSwap, Uniswap, and 1inch.
Centralised Finance (CeFi): What Is It?
Centralised Finance (CeFi) is still popular amongst many people. In addition, it was the norm in trading cryptocurrencies before DeFi was introduced. Centralised Finance may define itself with its name — it simply means that transactions are only complete when there is an intermediary involved.
So, if you have ever interacted with a cryptocurrency exchange, then you have participated in using CeFi. In CeFi, your funds are managed by the exchange and you do not have complete control over it because there are no private keys.
Users are also subject to the terms and conditions laid down by the exchange. Also, there is no anonymity as Centralised Exchanges (CEXes) require you to go through a Know-Your-Customer (KYC) process before making a transaction on the platform. Examples of Centralised Exchanges include Kraken, Binance, Coinbase, FTX, and the like.
Still, you may not be able to fully understand the disparities unless we make a clear distinction between them. So, in the next section, you will find the clear differences between both systems.
DeFi vs CeFi: The Key Differences
| DeFi | CeFi |
|---|---|
| No KYC required | Requires KYC |
| Can’t convert crypto to fiat or vice versa | Can convert crypto to fiat and otherwise |
| User has full control of assets in non-custodial wallets | Assets are in the exchange’s custody |
| Security depends on the technology | Exchanges are in charge of asset protection |
| Access to borrowing, trading, loans, and payments | Access to borrowing, trading, loans, and payments |
| No intermediaries involved | Transactions processed via central authority |
How Innovative Is Decentralised Finance?
Innovation has always been the backbone of almost everything within the crypto ecosystem. For DeFi, it is no different. Users will benefit from DeFi because it is peer-to-peer, permissionless, and likely to be very innovative and responsive to local needs. However, in comparison to centralised finance, it has several drawbacks. Larger intermediaries take on a lot of risks and offer a variety of extra services that users may or may not appreciate depending on their preferences. Protection against fraud and loss of security are two of the main features of DeFi.
In addition, users in the DeFi ecosystem must take responsibility for their own security and protect themselves from fraud. As such, DeFi users are likely to be prepared to pay for these services considering the value of the assets owned.
While new forms of financial assets, trade, and business models are being created as a result of (DeFi) applications, the use of blockchain technology to disrupt established financial services and institutions has also become more efficient. Additionally, DeFi has expanded beyond making transactions alone.
These days, payments, delivery confirmations, and health record updates are all examples of transactions that DeFi contributes to. Hence, the danger of depending on a single corporation, central computer, or server to maintain the source of truth has been reduced drastically by the underlying technology, which uses networks of computers to securely store data and authenticate transactions.
How Are Blockchain Technology and Decentralised Finance Connected?
In blockchain technology, data and transactions are forever kept, and history cannot be altered because of the way the system securely validates the data. The name “blockchain” is derived from the way data is organised—to protect the data, transactions are organised and kept in “blocks”’ that are time-stamped and cryptographically linked. In light of this, blockchain and DeFi are inter-related in some ways.
Investors and traders became used to blockchain technology throughout the years as cryptocurrency has been expanding in both centralised and decentralised finance. The major connection between DeFi and blockchain technology is that the latter backs it up and DeFi serves some of the purposes of the blockchain concept, which is making transactions without the interference of a third party.
The Security of Blockchain Technology
One of the main benefits of blockchains is their ability to provide security, which means they can protect and secure sensitive data from online transactions. Interestingly, DeFi and CeFi both contribute in this regard. In turn, cryptocurrency investors are mostly safe since data dissemination is automated and ownership balances on the blockchain are controlled. There are several other advantages to this structure, but more importantly, let’s briefly explain what Bitcoin is.
Bitcoin: The First Decentralised, Blockchain-based Crypto
Unlike fiat money and centralised state-controlled payment systems, Bitcoin and other cryptocurrencies are digital currencies that have been created to compete with or displace fiat currencies. Bitcoin, the first decentralised, blockchain-based cryptocurrency was created in 2009 by Satoshi Nakamoto, a pseudonymous inventor. This digital asset is not backed by any government-related policy. Bitcoin is popular, and has been accepted as a means of exchange in many venues, including cafés, bars, retail shops, and health services, among others. Despite the fact that it is not legal money in most jurisdictions, few countries have adopted it as their standard. Most notably— El Savador.
Diversity of Trading Through DeFi and CeFi
Trading in DeFi and CeFi are two very different things. In CeFi, users trade cryptocurrencies on exchanges. So, their assets are in custodial wallets and the risk of keeping the holdings safe and the obligation of putting them to good use is shared by these exchanges. In addition, users find no problem in converting crypto to fiat and vice versa using CeFi.
This makes customer onboarding easy for the exchange and convenient for the user. As for DeFi, the majority of users who have fiat money can’t use DeFi to convert them to crypto. Taking withdrawals in fiat currency, on the other hand, necessitates a crypto conversion. Hence, a centralised exchange has this obvious advantage over a DeFi platform.
Centralised finance systems, on the other hand, are not subject to such limits. CeFi is compatible with a wide range of popular coins that are usually produced on their own blockchains. In conclusion, CeFi services can take custody of funds from various disparate blockchains as trustworthy centralised exchanges. When completing swaps across different blockchains, DeFi services suffer from complexity and delay.