CeFi Or DeFi…that is the Question!
It’s reasonable to learn the differences between DeFi and CeFi before determining whether pursuing DeFi or CeFi as an alternative to long-standing financial systems is worthwhile. The initial concept of DeFi shakes the role of marker makers in entrusting institutional asset management like banks and brokers in different financial sectors.
With the expansion of cryptocurrency, it is still too early to make a solid judgment on whether it is a matured ecosystem to replace market makers as the next trusted alternative, but to better understand the evolution and the debate between CeFi and DeFi, maybe it will give you a heads up on the latest norm in the DeFi CeFi development.
What is DeFi?
Decentralized finance (DeFi) is a technology that books distributed ledger via applications built on top of blockchain where protocols and platforms are responsible for the transaction and exchange process without the role of the middle man.
DeFi intends to create a fair and transparent financial service ecosystem that is open and permissionless. Crypto borrowing, lending, and asset storage are among the services provided by the decentralized financial system.
Pros
DeFi means you have complete control over your assets and the keys to the users’ wallet. Users who want to participate in DeFi must utilize decentralized applications (dApps) created on the blockchain platform to access DeFi services.
1-Permissionless
The term ‘decentralized’ is the first and most important factor in determining the identity of decentralized finance. The decentralization of blockchain is one of its fundamental principles, where a transaction is made legitimate as long as there’s consensus, hence reducing the reliance on institutions.
To achieve all of the above, blockchain networks ensure that transaction histories may be easily shared across all members to achieve all of the above.
2-Immutability
Immutability has been made possible by the widespread adoption of cryptography and consensus techniques like proof-of-work. The immutability of the blockchain network makes it nearly impossible to alter any record.
Aside from such, immutability provides a certain degree of security. Interestingly, the immutability of the blockchain functions ensures that DeFi solutions carry out financial transactions with integrity.
3-Transparency
Transparency is one of the primary benefits of decentralization, and the distributed ledger keeps track of every transaction that takes place on the network. The open-sourced feature makes all transactions and codes accessible to everyone.
The blockchain’s cryptographic principles also ensure that information is documented only once authenticated.
4-Accessible P2P finance
Additionally, DeFi has played a crucial role in the growth of peer-to-peer lending and borrowing. The end-users of these loan and borrowing solutions can look forward to significant advantages.
Furthermore, they guarantee the incorporation of smart contracts. As a result, the need for intermediaries like banks, which are typically responsible for verifying parties in a transaction, can be eliminated.
Additionally, it serves to verify the loan and borrowing process, where smart contracts ensure verification procedures for loan and borrowing applications are made simpler and faster.
At the same time, DeFi protects the transaction’s counterparties. Faster transaction settlement and more access to DeFi applications in lending and borrowing would also benefit from these applications.
5-Tokenization
Tokenization is one of the most notable blockchain-related topics to have lately evolved. New crypto tokens can now be issued because of Ethereum’s extensive smart contract features. Essentially, crypto tokens were digital assets that could be stored on a blockchain and used for various purposes. Tokens specific to a single decentralized application (dApp) include utility tokens, real estate tokens, and security tokens.
Tokens can be used to accomplish a variety of tasks. Tokens for real estate may enable you to own a portion of real estate. On the other hand, security tokens could be used as digital shares. Tokenization, maybe most importantly, might increase the visibility of other assets, both real and digital.
Cons
1-Scalability
DeFi projects are unquestionably capable of facilitating financial inclusion for a broader audience. Despite this, DeFi initiatives face serious challenges in the scalability of the host blockchain from a variety of angles. The confirmation times for DeFi transactions are out of this world long to get things started.
Transactions on the DeFi protocols could also become extremely expensive during periods of congestion. For example, using Ethereum’s full capacity, the network could execute nearly 13 transactions per second. The centralized counterparts for DeFi, on the other hand, could handle thousands of transactions over that period.
2-Usability
Concerns about uncertainty influence the benefits and drawbacks of decentralized finance. If a blockchain hosting a DeFi project becomes unstable, the DeFi project could inherit the instability. The Ethereum blockchain is currently undergoing several improvements. For example, the faults made during the transfer from the old PoW consensus system to the new Eth 2.0 PoS method may lead to dangers.
3-Concerns of Liquidity
DeFi-based projects and blockchain technologies rely on liquidity, which cannot be overstated. During the first week of May 2021, the number of cryptocurrencies locked on the decentralized finance (DeFi) market dropped by almost $25 billion. It’s possible that the sharp drops in the value of more than a hundred different cryptocurrencies contributed to the departure of investors. Because of this, it may be concluded that the DeFi market is less than that of the traditional financial systems. As a result, it might be difficult to place your faith in a sector that lacks the familiarity of the traditional financial sector.
4-Security
A major selling feature of DeFi’s platforms is that they are extremely safe because they are decentralized and do not rely on a single third party to function. However, even if you lock your keys away, you can’t guarantee that your coins won’t get into the wrong hands due to human error or smart-contract malfunction. Hackers are motivated to uncover weaknesses in smart contracts because of the visible payout, which provides an incredibly large incentive. Such flaws have already cost decentralized platforms a lot of money.
What is CeFi?
Centralized Finance was the framework for trading cryptos until DeFi was launched. A central exchange handles all crypto transaction orders under centralized financing (CeFi) under their platform where certain authority oversees the central exchange’s funds. It signifies that you don’t have access to your wallet because you don’t have a private key.
When using a centralized exchange to buy or sell cryptocurrencies, you don’t own them. This concludes the notion of Centralized Finance. Additionally, you are bound by the rules imposed by a centralized exchange. Additionally, you are bound by the central exchange’s terms and conditions.
Pros of CeFi
1-Involvement of Middleman
“Rome was not built in a day.” Many CeFi exchanges built their name by successfully managing their clients’ funds for a long amount of time.
Blockchain technology might be difficult for many investors because it is a complex and fast-evolving sector. This is a shared obligation across exchanges. The reputable exchanges have 24/7 customer care teams that assist and advise consumers through these difficulties. Because of the recent changes in DeFi through yield farming, adoption is still difficult. It is difficult to convey complex DeFi use cases to crypto novices.
2-Flexibility
A centralized exchange is needed to convert fiat currency into cryptocurrency. This simplifies the exchange’s client onboarding process while also benefiting the exchange’s clients.
Customers who arrive at DeFi with fiat currencies will find that they cannot convert them to cryptocurrency. In the same way, withdrawing money in fiat involves a crypto-to-crypto conversion. That’s why it’s always a good idea to have a central exchange.
3-Diversity of Trading Options
Tokens used in the decentralized financial system must comply with Ethereum or platform-specific criteria. For instance, a DEX based on Ethereum only permits the trading of ERC20-based tokens via smart contracts on the DEX.
On the other hand, Centralized financial systems do not have these limits. CeFi supports a large number of well-known cryptocurrencies.
CeFi’s services can take custody of funds from various separate blockchains since they are trustworthy centralized exchanges. However, when it comes to swapping between several blockchains, DeFi services suffer from complexity and delay.
A wide range of CeFi services distinguishes them from their rivals. All coins with substantial trading volumes and market caps are exchanged on decentralized blockchains. Decentralized financing has not yet reached these autonomous chains.
Cons
1-Lack of autonomy
Users lose control of their funds when they use centralized platforms. The 1.7 billion unbanked individuals in the world who cannot explore numerous financial opportunities because of their incapacity to get into any system with strict regulatory standards are not encouraged by these platforms.
Users in CeFi entrust the exchanges with the custody of their assets. These exchanges also require them to divulge their personal information. It’s possible to lose money in the event of hacking or cyberattacks on the exchange. Privacy can be compromised even if the funds are safe.
2-Trust
It’s important to remember that centralized finance only works because of the openness of the transfer of assets and the accompanying dangers.
Almost all exchanges employ blockchain analysis businesses or blockchain forensics to reduce the risk of attacks and hacks. These businesses keep a close eye on all transactions, addresses, and funds transfers. Alerts are sent out in real-time whenever something suspicious happens.
Conclusion
The ultimate purpose of both decentralized and centralized finance is the same. They intend to popularize cryptocurrency trading and increase trading volume. While the goals of each ecosystem may be similar, the methods they use to achieve them are very different.
There is no absolute, let’s take Uniswap as an example. Uniswap is a fully decentralized exchange running on ERC-20. It’s fully automated where users can fully access the platform with 100% decentralized features and transactions…however, its lack of scalability means that there are no changes that would be allowed where no additional features could be added-on. Hence, we now see V2 and V3 of Uniswap with other different features, but remain to have a certain degree of centralization.
It was never about which side to take, but the degree of dependency and the balance in between the Pros and Cons of the two absolutely magnificent ecosystems.
