Moving from traditional finance into a new era of digital finance will require a shift from centralized to decentralized structures. However, centralized services are still dominant in the wider crypto industry despite a strong push towards more decentralized crypto products and services.
Read on to learn about the differences and similarities between centralized finance (CeFi) and decentralized finance (DeFi) in this beginner’s guide to CeFi vs. DeFi.
What Is CeFi and How Does It Work?
Centralized finance (CeFi) describes cryptocurrency products and services that depend on a centralized authority controlling the movement and storage of funds.
CeFi entities have a central location and servers. A good example is a centralized exchange (CEX), such as Binance or Coinbase, handling user funds and facilitating transactions.
Newcomers may prefer CeFi for its ease of use and familiarity. It is the gateway branching crypto to TradFi.
The CeFi platform facilitates trade using crypto and fiat currencies provided on the CEX. In some cases, users can also earn through lending and borrowing or use the deposited funds as collateral for a loan from the CeFi service provider.
Some CeFi use cases include:
- Trading: Centralized exchanges offer convenient trading spaces for crypto and fiat while remaining user-friendly.
- Lending and borrowing: CeFi lenders enable users to borrow and lend digital assets online.
- Cross-border payments: CeFi payments companies enable users to buy, store, and remit digital currencies anywhere across the globe.
What Is DeFi and How Does It Work?
Decentralized finance (DeFi) refers to Internet-native financial products and services that have no central authority in control while enabling users to retain custody of their funds.
DeFi protocols are permissionless, open-source, don’t require any KYC onboarding procedures, and use smart contracts to streamline transactions.
The barrier to entry are low and there are no biases preventing anyone from participating in the DeFi ecosystem. There are also fewer regulations in DeFi.
Some use cases of DeFi include:
- DEXs: DEXs are the decentralized counterparts of CEXs. They provide more complex trading options for pro traders.
- Lending and borrowing: Lending and borrowing in DeFi work similarly to CeFi platforms, where a user holds tokens that can act as funding or collateral for loans.
- Investment income earning: Staking and yield farming involves holding tokens provided on the platforms to earn investment income.
- Liquidity provision: Anyone can become a liquidity provider by deposting tokens in liquidity pools to increase the platform’s liquidity in exchange for a share in fees and additional rewards.
CeFi vs. DeFi: Similarities & Differences
Here is a comparison table for CeFi and DeFi:
|Underlying Technology||Centralized platforms||Blockchain|
|UI/UX||Easy to use; favors beginners||Complex; favors experienced crypto investors|
|Transaction Costs||Range from high to low||Relatively low, depending on the platform|
|Cross-chain Capabilities||Has cross-chain capabilities||Yet to reach the level of CeFi in terms of cross-chain activities|
|Regulation||Depends on high regulatory compliance, including KYC and AML||Low regulatory compliance, but it depends on the platform|
|Customizability||Not easily possible||Easily customizable|
|Examples||Coinbase, Crypto.com, Binance||dYdX, Compound, Yearn.Finance|
CeFi vs. DeFi: Pros and Cons
Here’s a look at some of the advantages and disadvantages of CeFi and DeFi.
- Offers a user-friendly, straightforward UI.
- Better cross-chain functionality allows for trading and info exchange across multiple chains.
- CeFi platforms offer 24/7 customer care catered to user needs.
- The regulated space makes it harder for bad actors to exploit users from within or outside the platforms.
- Lower chances of market manipulation due to the security procedures put in place on leading platforms.
- CeFi is vulnerable to attacks due to centralized servers.
- Often high transaction costs caused by intermediaries.
- No privacy or anonymity.
- Higher entry barriers prevent many potential users from joining centralized platforms.
- Self-custodial services in DeFi allow users to have complete control over their keys, personal information, and funds.
- Low entry barriers as no documents or onboarding processes are required to take part.
- DeFi encourages transparency, as all activity on-chain is accessible to anyone.
- Smart contacts and open-source code pave the way to various customizable services.
- It is a hard space to navigate as a newbie due to complex features.
- Low entry barrier allows bad actors to exploit the markets and ecosystems.
- Since it depends highly on the underlying tech, one bug could cost users millions in funds.
- DeFi is yet to achieve seamless cross-chain services.
- It lacks customer service, making it hard for users to find help in case of an issue.
Both CeFi and DeFi play a crucial role in the crypto industry. While centralized services ushered in the first exchanges, DeFi is now catching up with its more established counterpart, providing a more decentralized digital asset ecosystem.