What are the differences between DeFi vs crypto CeFi? Everyone who understands what finance is may not necessarily know the difference between DeFi and CeFi, especially when it involves crypto.
If you too are one among them, this is the right place to be. This article will inform you all about it in detail so that you know how exactly you can identify the best trading and investing options in this exciting space.
Typically, DeFi, or Decentralized Finance, is that which does not have any centralized bank over it or any other clearinghouses as well for that matter to oversee their financial operations.
Since cryptocurrencies are considered to be a financial product, Bitcoin is the first real ‘DeFi’ app and ETH is considered to be the largest platform as of now that offers DeFi services.
On the other hand, CeFi, just as the name implies, refers to the institutions and companies that store the funds of the users in order to provide different services.
Since most of the CeFi solutions are primarily related to cryptocurrencies, it is also called crypto CeFi. This means that whenever you trade on crypto exchanges like Binance, Coinbase and others, you are actually dealing with a CeFi service.
- Differences Between DeFi vs Crypto CeFi
- Which is Better – DeFi vs Crypto CeFi?
Differences Between DeFi vs Crypto CeFi
It is true that both crypto DeFi and CeFi have something in common in the sense that they both are related to offering the same financial services that include spot trading, margin trading, derivatives trading, payments, borrowing, lending, and even the creation of stablecoins.
The interfaces are intuitive for both and both are developed by the same people and organizations most of the time since both of them advocate digital currencies and blockchain technology. Check out Gold vs Bitcoin.
However, as an end user, you may not be able to make out whether or not the particular crypto service works on a DeFi or a CeFi infrastructure. Well, these differences listed below will help you to do so when you use a service in the future.
1. The Basics
DeFi, in simple terms, signifies a movement or trend that involves and promotes infrastructures that work on blockchain. This open-source software has the ability to create and help in providing all types of financial services and products apart from the traditional ones.
The services include lending, borrowing, staking, trading, payments, issuance of money, insurance, financial data, over the counter trading, asset management, and others.
In short, it is all about transforming conventional banking services to decentralized architectures in order to help the communities to manage all of these without having to rely on banks, financial institutions, regulators, or governments.
CeFi, on the other hand, was and is the standard for trading crypto assets and was introduced even before DeFi. Centralized Finance or CeFi typically has a stronghold in the cryptocurrency industry where all trade orders for crypto and funds are dealt via a central exchange.
In simple words, it means that you do not have to own the private key to access your wallet. Moreover, the centralized exchanges also identify the coins that they would list for trading as well as the amount you have to pay as fees to the exchange in order to trade with those coins.
In short, trading crypto coins through a centralized exchange means that you do not actually own the cryptocurrencies and you are subject to the rules and regulations set by the centralized exchange.
In DeFi, though most of the projects are developed by separate groups of organizations or people, the resultant platforms are typically controlled by the communities by using different and specific mechanisms.
Typically, the DeFi projects, irrespective of their kind, tend to mimic Bitcoin or any specific public blockchain in decentralization. However, for every case, there is a significant difference in the consensus algorithms.
There are a few DeFi projects that offer governance tokens as well. These tokens enable the holders to play a part in the decision making processes.
On the other hand, CeFi projects are usually governed either by a single or a group of entities that are responsible for running every single aspect of the business.
When it comes to the distinct features of the two services, most of the currently available CeFi projects provide custody solutions. Apart from that, these services usually have a knowledgeable and dedicated customer service team as well to provide adequate support to the users while trading.
In contrast, such customer support is usually not available in DeFi. When you trade on a DeFi platform, everything happens on the blockchain. This means that there is no involvement of a single authority.
This is due to the fact that the DeFi platforms come with several keys and unique features such as AMM or Automated Market Making, non-custodial swaps, yield farming, and liquidity pools.
In DeFi, there are usually no KYC requirements and the funds are typically held in the personal wallets till the time a transaction is executed. One of the most interesting features of DeFi is the tokenization of traditional assets.
This is actually a process in which digital units of any investment or asset are created by using blockchain and acts as collateral. These assets include commodities, forex pairs, company shares, stock indices and more.
As far as the regulation aspect is concerned, most of the CeFi platforms today need their users to go through the KYC or Know Your Customer verification process.
This is because the central authorities want to have some control over their operations. For example, in the United States, Coinbase is registered with SEC or the Securities and Exchange Commission but most of the other platforms that operate globally have shifted their headquarters to Malta, Estonia, or any other jurisdictions that are crypto friendly.
On the other hand, if you look at the European Commission, they are also on the verge of creating the most widespread legal framework for trading cryptocurrencies. In short, it can be said that there are more jurisdictions and regulations in relation to the CeFi services.
In contrast, when you look at the DeFi platforms, since it is decentralized in nature, there are little or no regulations on it anywhere. It is a relatively new trend and it is quite difficult to impose some specific regulations on the DeFi market.
However, according to the experts and based on several research papers, DeFi will pretty soon attract the regulators and specific regulations will be imposed on it not due to the boom in DeFi but specifically due to the money laundering conditions it has created.
Considering the fees, the centralized exchanges typically are more expensive in comparison to trading on the DeFi platforms.
This is because the CeFi platforms need quite a lot of money to cover their overheads such as salaries paid to the staff, improvement of their products and services, research and development, as well as maintenance of the platforms.
On the other hand, the DeFi platforms are much more affordable in comparison to the CeFi platforms to trade on. This is primarily due to the reason that they do not provide any custody services and also do not have a staff or team to pay salaries to for their governance and maintenance needs.
Typically, in such cases, the revenue generated from the fees is normally shared among the holders of the tokens and the liquidity providers when they decide to stake their tokens.
In DeFi, the way to achieve liquidity is quite different from the ways the CeFi projects do. Here, all of the trading usually is not carried out on the blockchain automatically. Rather, it is the AMMs that the DEX platforms mainly rely on to complete a trade.
This is a unique and far more effective concept. In this process, both the buyers and sellers involved in a particular trade are typically funded beforehand by the liquidity providers. This incentivizes them in locating the funds.
The trading fees, as mentioned earlier, are shared between the liquidity providers. Normally, the liquidity pools consist of two major constituents that make a trading pair namely, BTC and ETH. This means that the liquidity providers need to put in equal values of BTC and ETH by locking them both at the current rate.
On the other hand, the CeFi projects and platforms match the orders of the buyers and sellers of tokens in the same way as it is done by the stockbrokers and forex.
The CeFi platforms are more vulnerable than the DeFi platforms because the security measures of CeFi are not enough to prevent frequent instances of hacking even after the platforms put in their best efforts to ensure a high level of security.
According to reports, the CeFi platforms experienced the maximum number of hacking attacks in 2019 but the total amount of stolen funds was significantly reduced as compared to the amount of stolen funds in 2018.
The DeFi platform or the decentralized exchanges does not have such risks predominantly because the funds are typically not stored in the platform. This makes it much safer in comparison to the CeFi platform to use for crypto trading.
However, the users need to pay some attention to the consensus algorithm used as well as the codes involved in a DeFi project. In a few instances, there may be a few bugs or other issues existing in the underlying technology.
8. Potential and Prospect
The CeFi platforms have proved their potential and are still doing so by acting as the simulations of the traditional banks.
As of now, CeFi is still giving a strong competition to the DeFi projects by providing services that are equally fast and high yielding with its outstanding infrastructure intended for the communities.
The DeFi projects, on the other hand, are relatively new in the circuit and are still in the nascent stage. Therefore, there are not enough facts, figures and stats to prove its potential though several market experts, critics and industry onlookers predict that DeFi has the potential to bring in a major and most significant revolution in the financial system.
They even opine that the DeFi services may one day replace traditional banking systems since it has already started to pose a significant amount of threats to disrupt the existing system.
9. Risks Involved
Crypto trading involves a certain amount of risks but when it comes to DeFi, it seems to be a bit more. This is due to the fact that the DeFi tokens are much more volatile in comparison to the other available crypto tokens.
Therefore, it is advised that, while trading, you follow the best risk management techniques and when you invest in a specific coin make sure that you follow the rule of thumb: never invest more than you can afford to lose.
On the other hand, being centralized, the CeFi projects do not come with such volatility and risks. These projects also do not have a large number of pump-and-dump schemes and scams which is unlike the DeFi projects.
In terms of profitability and the impact on it due to the infrastructure, the DeFi tokens come with features that can enhance your profitability by a significant margin. All you have to do is identify the trend of the coins and the market as well and follow it accordingly with proper risk management measures in place.
Apart from Bitcoin, when you invest in coins that are well established such as the UNI, COMP, SNX, Maker, and KNC, you can expect to have a much more impressive return in the end.
However, in contrast, the CeFi projects may not be able to provide as high a return as the DeFi projects but still, these are good enough to consider. However, these projects usually do not have as much room to grow as the DeFi projects.
11. Future Expectations
If you consider only the medium-term future, then both DeFi and CeFi are quite promising. However, in the long term, DeFi projects are designed to thrive better than the CeFi projects.
This is because they both have a very low correlation with the conventional markets and therefore their importance as refuge assets will be much more as and when there is a financial crisis.
However, investors are advised to keep an eye on the changes in the regulations made with respect to DeFi projects due to the transition of Ethereum to Proof of Stake which will surely impact the upcoming sector.
On the other hand, the long term future of the CeFi projects is not as bright as the DeFi projects because the importance of blockchain solutions will not be stressed much when it comes to different types of financial services.
Governments will also play a significant part in the manipulation and control which may not make these services easily accessible to everyone.
The CeFi or centralized exchanges traditionally are used by the people to send funds that are stored and managed within the internal account of the exchange. Even though these are kept outside the custody of the users, they are still vulnerable to attacks and threats if, in case, the in-built security measure of the exchange fails.
On the other hand, the DeFi or decentralized exchanges follow a distinct protocol such as Ethereum. The encoded smart contracts are much safer and come with a complete set of instructions that allow making a transaction safely.
This is because the smart contracts and the users of the exchange are involved in a swap. Trade requests can be made easily without needing to move the funds outside the wallets.
These funds are simply transferred from one wallet to another according to the agreement in the smart contract of the exchange which makes it less vulnerable to attacks and thefts.
13. Fiat Conversion
The centralized services are much more flexible in comparison to the DeFi projects when it comes to fiat conversion. You can easily use these platforms to convert fiat to crypto and vice versa.
The users of CeFi are much more comfortable and convenient in such activities and can also expect to have a much better user experience.
On the other hand, the decentralized services do not allow such flexibility because conversion from fiat to crypto usually needs a central entity to execute the process which these DeFi platforms do not have and therefore cannot offer fiat on-ramps.
14. Cross-Chain Services
When you choose CeFi services, you will be able to trade different types of coins such as XRP, LTC, BTC and others that are based on autonomous blockchain platforms. There are no latency issues because CeFi can overcome them by receiving custody of funds from various chains.
This is quite beneficial for the traders because most of the coins that come with a high market cap and are frequently traded exist on the distinct blockchain and do not employ interoperability standards. Add to that, the ownership transfer also betters the intuitiveness and simplicity of the CeFi apps while using them for cross-chain services.
On the other hand, DeFi cannot provide cross-chain services because it cannot successfully deal with the latency issues and the complexities involved in such executions.
Therefore, DeFi does not support these particular coins for swapping as it is highly time-consuming which eventually affects the efficiency of the DeFi services. It cannot leverage multiple chains to take custody of funds and allow the users to enjoy the benefits of converting currency via sales or purchase orders.
Users of DeFi platforms do not need any permission to access it. They can do so directly and use the varied range of services provided by the platforms simply using their wallet. They do not need to furnish any of their personal information or deposit any money.
Since there are no discriminations or entry barriers and requirements regardless of the parties involved, this provides them with an additional benefit and peace in mind that the companies will not be able to use their personal information for their profits.
Moreover, it allows building freely on top of the decentralized platform and also allows collaborating with the community. With such benefits offered and useful products on the array, DeFi products are often called ‘money legos.’
In comparison, with CeFi, it is not possible to get such easy access. All users must go through their strict KYC process to use their services, as said earlier. In addition to furnishing their personal details, they will also need to deposit some money so that they can enjoy their services.
16. Trust Factor
The trust factor of the DeFi platforms is the most significant benefit and point of difference with CeFi. When you use a DeFi platform for trading crypto you will not need to trust anybody apart from the service.
This will perform as intended and you can yourself check it out by verifying and authenticating their services by using several external tools and auditing their code.
This will enable you to know whether or not a particular transaction was executed correctly. This means that with DeFi you will have the assurance that your funds are protected from wrong transfers or theft.
In comparison, the CeFi platforms do not offer such auditing features that will inform the users about the status of their transactions. Simply, it cannot ensure better support for monitoring a transaction or transparency in the process.
The closed CeFi services therefore fail to present and follow a global approach in comparison to the DeFi services. This is because the trust factor of the CeFi services depends usually on a particular system rather than on the whole process.
When it comes to innovation, it happens with DeFi at a much quicker rate. Typically, the Decentralized Finance ecosystem continually strives to better their existing capabilities and experiment with new ones to introduce for the better.
This specific character of the DeFi space has made it a rich ecosystem that offers the most innovative financial services. With better functionalities, the DeFi space delivers alternative ways that solve any issue most effectively and quickly.
One of the most significant features of it is that it allows the users to access tokens without needing to use them directly. All these experiments leverage decentralization and help in reforming the existing financial market.
CeFi, on the other hand, does not encourage innovation. This is because it follows a centralized approach. Though it does not absolve it totally, its potential to uncover new assets that may incentivize the users is quite low. This significantly affects the stages of growth and asset development.
Which is Better – DeFi vs Crypto CeFi?
It is true that both DeFi and CeFi offer a wide range of services related to crypto trading and investing. However, if you really have to choose between the two, here are a few things that you should consider and keep in mind.
You should go for the DeFi platforms if you prefer privacy and transparency over anything else. This is also a suitable platform for users who believe that technology reigns supreme and will perform as desired when it comes to execution of any or every service.
On the other hand, CeFi will be the best and most suitable model for you if you want to put trust, flexibility, risk sharing, and better and wider investment options on top of your priority list.
In a nutshell, it is all about your needs and personal preferences. It is all on you whether you prefer technology over people.
It is important to know the difference between the crypto DeFi and CeFi so that you can judge the way the society and financial system are moving. You will then be able to enter into the crypto space with more confidence and understanding.