DeFi or CeFi? What are the differences that might catch your attention? Let’s dive into the finance world together!
It’s not easy to define how each cryptocurrency derives its value. Some say Bitcoin is worth the cost of mining. But in general, a cryptocurrency is worth what you can sell it for. Markets decide how much a token is worth through transactions. This is where sellers bid up the price to get better deals and buyers bid lower to make a profit.
The Ethereum network has a daily trading volume of over $25 billion. And with so much money at stake, matching bids and asks can be incredibly difficult. Most cryptocurrency exchanges solve this problem by using a centralized platform to manage trade requests. And while this technically goes against the core principle of blockchain – decentralization – it has its advantages.
What is Centralized Finance (CeFi)?
Centralized Finance (CeFi) platforms are similar to structured financial services. They allow users to borrow, lend and earn interest on cryptocurrency assets. While the services are centralized, the goal of CeFi is to make trading more fair, efficient and popular. It also prioritizes decentralization more than traditional financial services, although most CeFi services rely on trusted third parties.
CeFi may represent stability and convenience, but high transaction fees due to intermediaries and a lack of transparency or absolute control over funds means that not everyone is in the same comfort zone. The cryptocurrency community values being able to make transactions that no one can censor. In a world where centralized exchanges can freeze funds or block withdrawals, people may flock to alternative platforms.
What is decentralized finance ( DeFi )?
While decentralized finance (DeFi) is one of the most sought-after areas of the blockchain industry today, the origins of the idea are much more humble. In fact, it wasn’t until the last few years that DeFi platforms became practical. While centralized exchanges used a central server to match bids and asks, decentralized exchanges found that using the same order book model across a distributed network was incredibly inefficient.
Last year, the introduction of Automated Market Makers (AMMs) brought decentralized exchanges to the forefront. With AMMs, decentralized exchanges abandon the traditional order book model. And instead use pre-funded liquidity pools consisting of at least one pair of tokens. Liquidity providers fund the pool for a portion of the trading fees depending on the proportion of the liquidity pool funded by them.
Privacy and KYC
Another important factor driving users to DeFi platforms is privacy. Centralized exchanges and other CeFi services usually require full KYC disclosure, but most DeFi platforms do not ask for personal information, nor are there any requirements to enter or exit fiat currencies. Instead of trusting a company, DeFi requires users to trust a protocol. While this prevents someone else from taking control of your funds, dealing with unregulated code in the blockchain space is always risky.
In the last few years alone, the total ETH locked on DeFi platforms has grown from almost zero to over $50 billion today. Currently, CeFi platforms are gaining more respect for their reliability and efficiency. But as DeFi continues to gain attention for its innovative, decentralized designs for financial applications, these platforms could threaten the dominance of some of the most prominent organizations in blockchain.
Key Difference Between DeFi and CeFi : Trust and Responsibility
DeFi platforms offer complete autonomy over funds. This means that your assets belong only to you and no one else can touch them without your permission. Compared to a regular international financial institution, DeFi also enables faster and more affordable payments across international borders due to lower overhead costs.
There are more than 2 billion people worldwide without access to banking or other financial services. Blockchain technology helps bring all kinds of money-related services to the remotest corners of the world, and with DeFi, anyone with a smartphone can start buying, holding and using cryptocurrency.
DeFi apps are also designed to work with each other, allowing for some impressive and incredibly profitable ‘yield farming’ strategies that span across multiple platforms. Since the data from DeFi platforms is publicly available, service providers also remain neutral. However, despite the immense popularity of these platforms, policymakers are still unsure how to regulate this space, which almost certainly stands out as one of the most significant barriers to institutional adoption.
Seond Key Difference: Regulation and Market Size
CeFi completely eclipses DeFi in terms of both user base and market size. Compared to DeFi, centralized platforms are much more established and have solidified their brand in the decade since the emergence of Bitcoin. DeFi, on the other hand, is a relatively young part of an industry that is still in its infancy.
While regulation is a growing issue in the blockchain space as a whole, centralized services have a much better chance of gaining regulatory approval because there is someone to take responsibility for enforcing it. Smart contracts can enforce regulations through code, but poorly written implementations can lead to significant financial losses for the market.
Also, since cryptocurrencies are still largely an enthusiast market, user experiences on DeFi platforms are relatively poor. Also the lack of customer support on decentralized networks could be what holds it back in the long run. However, while decentralized networks have faced obstacles since the launch of the first cryptocurrency, this problem will lessen over time as more sophisticated applications begin to hit the market.
However, another growing concern among community members is that centralized cryptocurrency exchanges will adopt similar operations to traditional banks. This has in part led to the rise in popularity of DeFi platforms. While both types of services are necessary in different ways, their future will depend on how well DeFi platforms can mimic the performance of their centralized counterparts.
CeFi services understand exactly what they want from their customers and try to push their user base in that direction. DeFi platforms, on the other hand, define themselves by how the community uses them, and this is an important distinction to make. For novice traders just starting out, centralized platforms are much more streamlined and easy to use, while decentralized alternatives are designed more for experienced users.
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