Historically, the operation of money markets and financial assets has been based on centralised models. Consider the US dollar. The world's most traded currency, the US dollar, is managed by the United States government, which controls how many dollars are printed in circulation.
On the other hand, cryptocurrencies seek to challenge this centralised model by offering a decentralised alternative. Most digital assets are governed by an algorithm that dictates how many coins are released in the market.
Taking its roots from this concept, decentralised finance (DeFi) has emerged as a popular solution within the cryptocurrency space. It is an umbrella term that encompasses a wide variety of blockchain-based financial applications that seek to root out intermediaries. Challenging the notion of DeFi is its counterpart, CeFi (centralised finance).
In crypto, however, the terms DeFi and CeFi cannot be used interchangeably, as both have distinct differences. Let us understand what both the terms mean and how they are different.
What is DeFi?
As mentioned earlier, DeFi enables cryptocurrency transactions without the need for any intermediaries or central authorities. Instead, DeFi relies on smart contract functions and decentralised applications (dApps) for its working. Smart contracts are programs within a network that are executed when certain conditions are met. In other words, smart contracts cut out any third parties by self-executing certain transactions. Some common examples of DeFi applications are decentralised exchanges (DEXs), lending platforms, and stablecoins, among others.
What is CeFi?
You may be wondering what centralized finance (CeFi) has to do with cryptocurrencies since the latter revolves around the concept of decentralisation. But the reality is that some cryptocurrency trading was largely done through CeFi before its counterpart, DeFi, was introduced.
CeFi refers to crypto transactions that are accomplished through a centralized entity. A prime example of this would be how a centralised cryptocurrency exchange operates, such as Binance and Coinbase, among others.
These exchanges are in charge of facilitating transactions between two parties. More specifically, the exchange determines the price at which a cryptocurrency can be bought or sold, as well as when and how withdrawals can be made. The exchanges also establish trading fees and execute fund management functions.
Also Read: Crypto airdrop phishing scams: What are they
CeFi VS DeFi: A comparison
Security: Security features of any platform are of extreme importance, considering the growing number of thefts within the crypto space. Although both concepts are susceptible to hacks, many consider decentralized platforms, such as DEXs, to be a safer measure than centralised platforms, such as CEXs. If a central exchange falls victim to thefts, you may end up losing all your digital assets and there is no guarantee that you will be completely refunded for your losses. In contrast, there is no central entity to manage your funds in a DEX. Instead, you rely on the security measures provided by the DEX. If smart contracts are well-designed, security breaches are less likely on DeFi platforms.
Custody: DeFi platforms allow a user to be in charge of their funds to a greater degree than CeFi platforms. Let us consider DEXs and CEXs, for instance. When you buy crypto through a CEX, the exchange essentially retains control of your private keys. It can also choose when to allow users to withdraw their funds. At times, they can even halt the withdrawal process. The same is less likely to occur on DEXs, which have no central authority to manage your funds.
User Experience: In terms of user experience, many might prefer the easy-to-use CeFi platforms over DeFi platforms. This is because CeFi platforms, such as CEXs, provide a wide variety of options such as margin trading, fiat conversion, cross-chain support, and customer service. On the other hand, DeFi platforms can be much tougher on an amateur crypto investor, since they are built on complex algorithms and smart contracts.
Cost: When it comes to cost, one would often find it cheaper to transact on DeFi platforms as it typically offers lesser fees than CeFi alternatives. This is because CeFi platforms decide how much fees you need to pay. This fee may change, depending on the liquidity of certain cryptos in the market.
Conclusion
Although the article discusses the distinctions between CeFi and DeFi, you should consider them to be two sides of the same coin, and using either is primarily a matter of personal preference.
Both models utilise blockchain technology to further the agenda of cryptocurrencies. Furthermore, both have shown a track record of success over the years within their respective fields. Moving forward, developments in both, CeFi and DeFi applications, would likely contribute greatly to cryptocurrency adoption.
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