Ines AissaniWe will see in this short article from the "Education" category, the difference between CeFi and DeFi, because even if it seems easy and we all more or less have the impression of knowing the difference, it turns out that it is always better to understand in depth what opposes them.
We started talking about decentralized finance with the advent of Ethereum, especially when decentralized applications could be implemented. To the extent that these applications provided us with financial services operating on the blockchain, it was necessary to distinguish between centralized finance and decentralized finance.
So, in a simple explanation, when we talk about decentralized finance, it is to mark the fact that it happens on the blockchain. DeFi indeed means Decentralized Finance. Conversely, classic and centralized finance is therefore called Centralized Fiborn. (CeFi).
Now that the simple definition is established, let's see the advantages and disadvantages of CeFi and DeFi, to better understand the issues.
What is centralized finance (CeFi)
Before the appearance of DeFi, centralized finance was the ultimate for finance, let it be said. There was only centralized finance. In other words, all financial services were based on the same centralized infrastructure. All orders, all operations are processed and executed via a central server.
The funds and capital of private individuals or companies are managed by a regulated financial institution such as a bank, a management company, etc. In other words, it is not the people who have their own access to the wallets. It is these approved institutions which will carry out all operations concerning it.
The individual or company does not then have full control of their assets, or even of the operations they wish to carry out. She must constantly refer to the institutional intermediary.
Important note: You should know that just because we talk and use cryptocurrencies does not mean we are on a decentralized platform. It is the fact that we have our private keys or not that will actually determine whether we are dealing with a centralized platform or not.
Characteristics of Centralized Finance (CeFi)
We will look in more detail at centralized exchanges, CEX ( Centralized Exexchange). When using centralized exchange platforms like Binance, Kraken or probit for example, these are centralized platforms. Indeed, the funds that are deposited on the platform are then "kept" and maintained by the platform. That is to say, users do not have their own keys. And besides, to register on these platforms, you have to enter your email and password. You do not have your own private keys as is the case when using a fully decentralized platform.
We are therefore subject to possible risks and hacks that the platform may suffer. These are events that have regularly occurred on CEXs even if today, it is becoming increasingly rare.
Also, a centralized exchange platform has the particularity of operating like a real company, with complete services, customer service teams, teams dedicated to security, etc. We are dealing with a real company, legally registered in a country and which seeks to offer the best to its customers. Indeed, in the event of loss of capital or any hacking, the responsibility falls on the platform to resolve the problems encountered.
Payments in fiat currencies
The other essential element to understand and in which we can better understand how today, CEXs prove to be essential, despite everything. This element is the possibility of depositing fiat. In fact, this is precisely what makes centralized platforms essential (for the moment?) in the cryptographic universe.
To pay by credit card, the platform must then be registered and must operate within a legal framework that it must follow.
We can then convert fiat/crypto reciprocally and this is also what makes exchanges so practical, unlike, in any case, decentralized platforms.
Cross-chain services:
The other very useful point of centralized platforms is the fact that we can easily integrate (especially in trading) cryptos from different blockchains. Even if this is starting to change thanks to bridge services which allow interoperability, you should know that this is for the moment the great advantage of centralized platforms, namely the possibility of obtaining different cryptos easily, and on, the same platform.
There you have it, a simplified understanding of how centralized finance and centralized platforms work as well. Let's see now what happens to its diametrically opposite counterpart.
What is Decentralized Finance? (Challenge)
DeFi refers to a whole very broad ecosystem of open source, authorization-free and transparent financial services. In decentralized finance, we find everything (or almost) that we have in classic finance such as lending/borrowing services/deposit services blocked for rewards. In fact, with DeFI, financial services have even opened up. The decentralized financial system offers services including borrowing, yield farming, crypto lending, asset storage and more.
When we talk about decentralized finance, we are also indirectly talking about automation. Indeed, decentralized platforms operate with Smart contract who will operate and carry out all the operations. These are platforms open to everyone. These platforms are therefore by definition open to unbanked people who can then access the most innovative financial services available.
Thus, the great advantage of DeFi over CeFi lies above all in this that we have total control over our assets and that we are the only ones to know on the one hand the amount of our capital and that we are the only ones to decide to its use. We control and carry out the operations ourselves.
What are the pros and cons of DeFi?
Ultimately, what results from the difference between CeFi and DeFI is the trust placed in one or the other. You will see that it is not at all easy when you have to decide where to invest your funds.
When you decide to operate on a decentralized service, you rely entirely on the technology behind it. We have no other choice, because there is no central server that could retrieve our requests for example.
Conversely, when you deposit your funds in a centralized service, then, in this case, the responsibility is shifted to the employees of the service. There is a manager and a responsibility in centralized finance. If the site is hacked, the company will use its insurance for example and will try to reimburse the hacked amounts.
So, we can really say that the big difference lies in the trust we want to grant, but, obviously, this is not the only difference even if it will cover many.
The characteristics of DeFi
Without permission (Permissionless)
This is the primary characteristic of DeFi. This means that users, unlike CeFi, do not need to complete a KYC process to access the services. They do not have to share their personal information to use the services. It is open and accessible without permission to everyone, regardless of a person's origin or nationality. This is also what makes the ultimate strength of DeFi.
LegoMoney
It is a term that we often find and which refers to the idea that financial services are built in relation to each other. We can integrate them, accumulate them even on a platform. They communicate with each other and that is why we legitimately talk about Lego money.
Without trust
Again, this is an essential feature of DeFi. You do not need to trust that the service will work as expected. You don't trust a person in charge of the results, but a computer program. You have external tools like blockchain explorers to verify that a transaction has been carried out, for example.
Conclusion on DeFi vs CeFi
This is what you should remember about the differences between CeFi and DeFi. We could add other indirect elements such as the fact that DeFi turns out to be much more innovative than its counterpart. The DeFi ecosystem is evolving so quickly that we don't yet have the time or perspective to write our own economy ( tokenomics).
We can truly say and affirm that DeFi in its principle is absolutely revolutionary because it allows democratizing access to finance for everyone, without any discrimination.
That said, as I write this article, I do not think we should put the differences between DeFi and CeFi in qualitative terms. For the moment, both universes have their own uses. The two universes enrich each other and there is good and bad, to put it roughly, in both models.
Each profile can find something to suit it, in reality. If you prefer the transparent model, open to all and in which you are solely responsible (even in the event of loss). On the other hand, if you want to put your capital to work in a more peaceful and supervised manner then, in this case, CeFi will suit you best.
In my personal case, I must say that I like to use both models and that depending on the capital invested, I sometimes choose centralized platforms while for other services, I opt for DeFi (do we really the choice to practice Liquidity mining or Yield Farming, hmm?).
I hope it’s clearer for you now 😉
