The prospects of decentralized finance have undoubtedly presented a new and productive alternative for traditional financial systems. Therefore, the debate over DeFi vs CeFi or centralized finance is gaining momentum in radical proportions in recent times. Decentralized finance has emerged as a prominent contributor to resolving numerous pitfalls in traditional financial services.
However, it is reasonable to find out the difference between DeFi and CeFi to ascertain the validity of pursuing DeFi as an alternative to financial systems that have been functional for an inexplicably long period. Is it reasonable to shift from the financial systems trusted by all individuals using financial services worldwide? The following discussion dives into a head-to-head comparison to provide a better impression of the CeFi DeFi debate.
Also Read: Beginner’s Guide to DeFi
Starting with the Definitions – DeFi and CeFi
Before the reflection on differences between CeFi and DeFi, let us focus on what is CeFi. It is an abbreviation for centralized finance referring to the closed financial markets. On the other hand, when we reflect on what is DeFi, it is evident that it is the opposite of CeFi. Decentralized finance points out the different tools, frameworks, and technologies that enable open, secure access to financial services with assurance of flexibility and control.
The Dominant Traits of CeFi
The definitions of DeFi and CeFi point out the differentiating factor of a centralized entity, which dictates the level of trust with each approach. If the trust is vested in the business itself, you can identify it as a trait of CeFi. As a centralized approach, CeFi implies that a business has to ensure management, execution, and sustenance of trust with ethical measures at any cost.
In the event of a breach of trust, end-users are less likely to exhibit trust in a CeFi business. CeFi also presents credible advantages of flexibility by adapting services such as fiat conversions, direct service, and cross-chain exchanges according to customer needs. To improve our understanding of DeFi vs CeFi, let us discover how CeFi is different from DeFi before proceeding towards the distinctive factors about DeFi that separates it from CeFi.
Here is a table that can help you point out the DeFi vs CeFi differences easily in the simplest way possible
|Criteria||Centralized Finance (CeFi)||Decentralized Finance (DeFi)|
|Conventional trading activities (margin trading, payments, derivatives trading, lending, and borrowing)||Allowed||Allowed|
|Customer support||Tailored for customer needs||No direct assistance with limited support|
|Fiat to Cryptocurrency conversion||Allowed||Allowed|
|KYC requirements||Mandatory requirement for accessing CeFi services||No need for KYC to access DeFi services and only a unique identification number is required|
|Liquidity||Not applicable for all assets||Not applicable for all assets|
|Support for Stablecoins||Permitted||Permitted|
|Transfer of Custody of Funds||No transfer of custody of funds in investments made by a centralized entity||Transfer of custody is imperative for DeFi transactions|
|Transparency of Transactions||A centralized entity takes away transparency completely||Open-source nature of transactions strengthens transparency|
|Trust||Focused on business||Focused on technology and process|
The centralized exchanges accompany vulnerabilities of user funds to internal and external threats. Centralized services manage user funds and data in centralized systems, thereby implying the lack of absolute safety for user funds and information. The DeFi vs CeFi debate turns in favor of the former due to security concerns.
However, centralized exchanges offer cryptocurrency trading and trading functionalities like margin trading, lending, borrowing, and OTC, among others. Therefore, CeFi brings flexibility for customers while addressing issues that could take specialized efforts and guidance for resolution.
Flexibility to Convert Fiat Currency
Another highlight in the DeFi vs CeFi debate in favor of CeFi is the flexibility of working with fiat. The flexibility accompanied by a centralized entity responsible for managing fiat allows formidable control to customers for ensuring fiat conversions.
CeFi is also known for the facility of cross-chain services with the support for cryptocurrency trading. Users can ensure LTC to XRP or BTC to LTC conversions without depending on blockchain technology underlying different cryptocurrencies. On the other hand, DeFi is not capable of providing cross-chain services. For example, the atomic cross-chain swaps could be highly time-consuming with higher latency, thereby preventing the efficiency of DeFi services.
So, CeFi emerges as a winner in the DeFi vs CeFi debate regarding cross-chain services. CeFi leverages multiple chains for taking custody of funds before permitting the conversion or trading of coins. End-users could easily get the benefits of converting currency through orders for sales or purchase. The transfer of ownership also improves the simplicity and intuitiveness of CeFi applications in cross-chain services.
Want to have a quick overview of Decentralized Finance? Here is the Quick Guide to DeFi.
How is DeFi Better than CeFi – DeFi vs CeFi
After a comparative evaluation of CeFi vs DeFi, let us turn the tables and look from the other perspective. DeFi does not impose any requirements for establishing user identity for accessing financial services. Rather than depending on the personal information of users, DeFi services provide a unique identification number to users for leveraging banking services.
As a result, users have the assurance of safety of their funds and data with all aspects of security vested in the user’s responsibility. Let us take a look at the other factors in the DeFi vs CeFi comparison from the perspective of DeFi.
DeFi is capable of providing decentralized exchange platforms that do not have any centralized systems. DEX platforms leverage smart contracts in unison with decentralized protocol solutions and Ethereum. The design of smart contracts also ensures better automation of fulfilling necessary orders. Users of DEX-based systems don’t have to go through the sign-up process for using the concerned service.
The connection of user wallet to DEX service is enough to enable trade on DEX platforms. Apart from the setback of lack of support for cross-service solutions, DEX services enable trading in cryptocurrencies without funds to withdraw from user wallets. The transfer of funds happens only after the execution of the trade to provide a comprehensive guarantee of the safety of funds.
DeFi vs CeFi debate also points out the permissionless nature of the former. As a result, users don’t need a KYC process like in CeFi services to use DeFi services. Users can connect their wallets to DeFi service, followed by taking necessary actions like fund transfers, trading, and many others.
Additionally, there is no restriction on access to DeFi services due to its permissionless nature. Furthermore, enterprises can leverage DeFi services for the welfare of the general public. At the same time, enterprises can also use DeFi services to expand their business to unreachable geographic locations.
Another promising highlight in favor of DeFi in the DeFi vs CeFi debate is the support for innovation. Many players in the DeFi ecosystem are striving for innovation at a rapid pace. The experiments on leveraging decentralization for reforming the existing finance market, along with the arrival of new financial services paint DeFi, is a positive light. On the other hand, CeFi does not foster innovation due to the centralized approach, albeit without absolving it completely. DeFi also presents a better potential for uncovering new assets with the facility of incentives to users involved in the stages of asset development and growth.
The final bit of comparison between DeFi and CeFi points out directly to the trustless factor. The trust factor in DeFi depends on the complete process rather than on a specific system. As a result, users can assure their funds from theft or wrong transfers with DeFi. The auditing of DeFi services by developers informed users, and interested entities ensure better support for transparency and monitoring of transactions. Therefore, DeFi services present a global approach in comparison to closed CeFi services.
If you are still wondering about the adoption of DeFi (Decentralized Finance) by the enterprises. Check out the Top DeFi Projects of 2020.
On a concluding note, you can notice the various pointers in a DeFi vs CeFi debate. The facility of liquidity is a formidable similarity amidst all the differences between the two financial systems. Both CeFi and DeFi allocate equal price value for specific assets. However, DeFi presents a formidable advantage over CeFi in many aspects, albeit failing in the facility of cross-chain services.
Except for such setbacks, DeFi is a clear and promising alternative to centralized finance with the facility of better control over financial investments. Most important of all, DeFi has the potential of making financial services accessible to the general public. Start exploring more in the world of DeFi right now to understand it better!