With the emergence of Decentralized Finance in the crypto industry, the debate on CeFi and DeFi is quite trending. The debate majorly focuses on decentralization which is the integral component of the cryptocurrency ecosystem.
Although Bitcoin initiated a global transition towards decentralization, some parts of the ecosystem have epitomized centralization. The two systems have similar services like credit, interest, stable currency, exchanges, and assets. But they use a different approach.
Let’s have a look at how the two financial systems differ from each other.
Definition of Centralized Finance (CeFi)
In CeFi, users trust the people behind the business to manage funds and execute the services that the business offers. The main advantage of using is that it offers flexibility, because of which fiat conversions, cross-chain exchange, and the ability to directly help customers by handling funds are made possible.
Most people find it difficult to self-manage their own money, wealth, goods, and belongings… They make stupid mistakes as well as fall into clever traps (Scams). Then they need someone to do/fix it for them so they can sleep peacefully. Examples are Banks, Centralized exchanges.
Definition of Decentralized Finance(DeFi)
In DeFi, users trust that the technology will work in order to execute the services being offered. DeFi allows users to access financial instruments using smart contracts built on the Ethereum blockchain. DeFi allows its users to lend and borrow, flash loans, insurance, derivatives, permissionless trading.
Users can get the maximum benefits by controlling their money via smart contracts. They can lend and borrow with much better rates than the Centralized platforms offers. Examples are Decentralized exchanges (DEx), Smart contract-based lending platforms.
- Custody: CeFi is custodial as it holds customer data and funds. While DeFi is non-custodial as users lock their funds in smart contracts to access financial services.
- Cross Chain Services: CeFi supports trading of BTC, LTC, XRP, and other popular cryptocurrencies issued on an independent blockchain. Due to the complexity and latency of performing atomic cross-chain swaps, DeFi does not support these coins.
- Fiat to Crypto: Centralized services provide good flexibility, so fiat to cryptocurrency conversion and vice versa is much easier. While most DeFi services do not support fiat to cryptocurrency conversions.
- Trust: In CeFi the user should trust on the third-party to deposit their funds. Whereas, DeFi is trustless as the users can monitor the DeFi services and their transactions by using external tools like EtherScan.
- Verification: With CeFi users should provide their personal information or deposit funds to access the CeFi services. While with DeFi users can access the services by just using a wallet.
- Governance: In CeFi, corporate management will take care of decision-making in both the current and future states of the companies. While in DeFi, the communities consisting of platform governance token holders will manage the platforms.
- Interest Rates: The CeFi platforms hold the power to define the interest rates. While the DeFi platforms depend on the market data and proprietary data obtained from market participants. Then, the governance token holders can vote on the adjustment of interest rates.
- Oracles: The centralized oracles operate as a single entity offering the data from an external source to a smart contract. While in DeFi, the decentralized oracles depend on multiple external sources to increase the authenticity of data provided to smart contracts.
CeFi is in the market long before the emergence of cryptocurrencies. While DeFi, on the other hand, has made a recent entry into the industry and is growing rapidly. Both of them have a good base in the cryptocurrency movement. DeFi and CeFi offer attractive yields, faster transactions, and infrastructure that enhances the open finance.