Traditional financial services like loans and payments were only offered by banks and financial institutions. It changed with the advent of blockchain technology. As cryptocurrency became more popular, discussions shifted to a new set, which included decentralized and central finance (CeFi).
What is Centralized Finance?
Prior to DeFi, Centralized Finance was used for trading cryptos. It has a strong hold on the cryptocurrency market. All crypto trade orders in centralized finance (CeFi) are processed through a central exchange. The central exchange is responsible for managing funds. This means that you do not have a private key to access your wallet.
The exchange also lists which coins are available for trading and what fees you will need to pay in order to trade with them.
The concept of Centralized Finance states that you don’t own your cryptocurrency when buying/selling through a central exchange. You are also subject to the rules that a central exchange places on you. You are also subject to rules established by the central exchange.
What is Decentralized Finance? (DeFi)
The decentralized exchange does not involve any exchanges. The entire process is made possible by automated applications built on top of blockchain platforms. Decentralized finance also creates an open and fair financial system that anyone can access. This technology allows people who are not banked to have access to financial and banking services using blockchain technology.
DeFi’s goal is to create an open-source, transparent and permissionless financial services ecosystem. Decentralized financial services include borrowing, yield farming and crypto lending. Asset storage is also available.
DeFi has the advantage over CeFi in that you can control your assets and have access to your key pair. Decentralized applications (dApps), which are built on blockchain platforms, are required for users to access DeFi services.
What is DeFi and CeFi different?
DeFi and CeFi have many similarities, but the real question is whether people should trust technology more than technology.
DeFi users can trust that the technology will deliver what is promised for services. CeFi on the other hand, allows users to trust the people of a business to manage the funds and deliver the services.
Both DeFi and CeFi deliver a wide range of cryptocurrency-related financial services. Let’s look at some of the differences between the two ecosystems.
CeFi Features
- Centralized Exchange (CEX).
Users can send money to a traditional cryptocurrency exchange such as Binance, Kraken, or Coinbase to manage their funds within an internal account. Although funds are stored on an exchange, they are not subject to users’ custody and could be exposed to security breaches.
Security attacks have targeted centralized exchanges as a result. As they trust central exchanges, customers who use centralized exchanges don’t mind sharing their personal data or putting money into their custody.
Large exchanges often have departments that offer customer support. Customers feel more comfortable knowing that they are in good hands thanks to the high quality customer support.
- Fiat Conversion: Flexibility
When it comes to converting fiat into cryptocurrency or vice versa, centralized services offer more flexibility than decentralized services. A centralized entity is required to convert fiat and cryptocurrency. However, DeFi services don’t offer that flexibility.
Customers can be enrolled in the Centralized Finance ecosystem (CeFi) quite easily and offer a better customer experience.
- Cross-chain services
CeFi services allow you to trade LTC, XRP and BTC on independent blockchain platforms. DeFi services are unable to support these tokens due to the complexity and latency of cross-chain swaps. CeFi can solve this problem by obtaining custody of funds from multiple blockchains. CeFi can take advantage of this opportunity as many of the most traded and high-market-cap coin are on their own blockchains. They don’t have to implement interoperability standards.
DeFi Features
- Permissionless
DeFi is available to all users without their permission. To access CeFi, users must complete a KYC process. This means that they will need to deposit money or share personal information.
The services can be accessed directly via a wallet without the need to provide personal information or deposit money with DeFi. DeFi is accessible to everyone, without discrimination or barriers.
Individuals who want to build on top a decentralized platform are also allowed to do so freely. It allows for high accessibility and encourages collaboration within the community. The DeFi ecosystem is designed to help each other. DeFi products are sometimes called money legos.
- Trustworthness
DeFi services offer a significant advantage: you don’t have to be sure that they will work as advertised. DeFi service users can verify that they work as advertised by auditing their code. External tools like Etherscan are available to help determine if a transaction was executed correctly.
- Quick Innovation
DeFi’s rapid rate of innovation is another advantage. The Decentralized Finance Ecosystem constantly builds new capabilities and experiments with new ones. DeFi’s build-centric approach has resulted in a rich ecosystem that offers innovative financial services.
DeFi space has worked to find alternative solutions to problems where central financial services thrive. To overcome DeFi’s inability of facilitating the transfer of incompatible cryptocurrencies like BTC, solutions such as tBTC or WBTC that are compatible to decentralized protocols close the gap by acting as tokens pegged at the value of BTC. This allows DeFi users to access Bitcoin through DeFi without the need to use the token.
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