What is Defi and Cefi | Decentralized finance vs. Centralized finance

Traditional financial services such as payments, lending, and borrowing were only available via established financial institutes and banks. But it transformed with the introduction of blockchain technology. When the idea of cryptocurrency started expanding, the discussion pivoted to a new set of considerations, i.e., decentralized finance (Defi) and centralized finance (CeFi).

What is Centralized Finance (CeFi)?

Before Defi was introduced, Centralized Finance was the pinnacle for trading cryptos. It handles a stronghold over the cryptocurrency industry. In centralized finance (CeFi), all crypto trade orders are managed through a central exchange. Funds are managed by specific running the central exchange. It means you don’t own a private key that provides you access to your wallet.

Moreover, the exchange identifies which coins they list for trading or how much fees you need to pay to trade with their exchange.

Concluding the concept of Centralized Finance, you don’t own your cryptocurrencies when buying /selling via a centralized exchange. Moreover, you are subject to a centralized exchange’s rules. Also, you are subject to the regulations set by the centralized exchange.

What is Decentralized Finance? (Defi)

No exchange is involved in the decentralized exchange. The complete process operates via automated applications developed on top of blockchain platforms. Also, decentralized finance creates a fair and transparent financial system where anyone can partake. It allows unbanked people to access financial and banking services via blockchain technology.

Defi aims to construct an open-source, permissionless, and transparent financial service ecosystem. The decentralized financial system offers services, including borrowing, yield farming, crypto lending, asset storage, etc.

The perks of using Defi over CeFi is that you have complete control over your assets and own the key pair for your wallet. Moreover, users who want to participate in Defi require to use decentralized applications (dApps) built on blockchain to access Defi services.

Differences between Defi and CeFi

One of the most notable differences between decentralized finance and centralized finance is that the system is regulated in the case of CeFi. In contrast, precisely the opposite is the case with Defi. In centralized finance, the responsibility of protecting the users’ money is with the exchanges. On the other hand, the assumption behind Defi is that the transactions would be successful as a result of smart contracts (an agreement between two parties that enforces specific rules/terms of negotiation when a particular/specific condition is met). The users are liable for managing their funds and activities in simple terms. In CeFi, it is possible to prevent trade and impose limitations on users. However, the same is not possible in the case of decentralized finance. Decentralized finance is permissionless, whereas this is not the case with CeFi. There are two areas where CeFi stands apart — One, the CeFi exchanges enable the conversion of fiat currency to cryptocurrency and vice-versa easily and seamlessly.

Features of CeFi

Features of Defi

How do they work

Although centralized exchanges (CEXs) currently dominate cryptocurrency trading activity, decentralized exchanges (DEXs) are growing in popularity. DEXs facilitate peer-to-peer trading by relying on automated smart contracts to execute trades without an intermediary. However, not all DEXs employ the same underlying infrastructure. While some retain conventional order book models, others use emergent liquidity protocols. In addition to exchange and liquidity protocols, developers are building new aggregation tools to address the disjointed liquidity that’s inherent in decentralized exchanges.

Decentralized Exchanges (Order Book)

There are multiple generations of decentralized crypto exchanges and Defi products. The first generation of decentralized exchanges uses order books, similar to conventional centralized exchanges. These order books compile a record of all open buy and sell orders for a particular asset. The spread between these prices determines the depth of the order book and the prevailing market price. On DEXs with order books, this information is often held on-chain during trades, while your funds remain off-chain in your wallet. Many DEXs specialize in a particular financial instrument that is executed in a decentralized manner.

Decentralized Exchanges (Swaps)

The next generation of decentralized exchanges does not use order books to facilitate trades or set prices. Instead, these platforms typically employ liquidity pool protocols to determine asset pricing. Peer-to-peer in nature, these exchanges instantly execute trades between users’ wallets — a process some refer to as a swap. The DEXs in this category are ranked in total value locked (TVL), or the value of assets held in the protocol’s smart contracts.

Decentralized Exchange Aggregators

Decentralized exchanges use several different protocols and mechanisms. Although this dynamic results in higher security and autonomy, it also results in disjointed liquidity across platforms. This lack of liquidity can be a deterrent for institutional investors or wealthy independent traders who want to purchase a select crypto asset in large volumes. To address this, DEX aggregators have developed tools to deepen asset liquidity pools across centralized and decentralized crypto exchanges.

Centralized exchanges

Binance is the biggest cryptocurrency exchange based on the average daily volumes being traded. It provides hundreds of currencies for trading and charges relatively lower fees than other commonly used exchanges. It also offers advanced charting systems without the user having to upgrade.

Coinbase has primarily avoided any crypto fraud so far and provides a robust platform for trading. It also offers a Pro version with significantly lower transaction costs and significantly more technical features. Coinbase allows transactions in 64 cryptocurrencies.

Decentralized Exchange Evolution

Although centralized exchanges account for the vast majority of market activity since they offer security, regulatory oversight, and often insurance, the growth of Defi has created room for the development of decentralized crypto exchange protocols and aggregation tools. Platforms like Uniswap, Curve, and Balancer display the potential for simple, user-friendly platforms that rely on liquidity protocols rather than order books. As the DEX market matures, the proliferation of new protocols and supporting mechanisms will likely only accelerate.

Conclusion

Both Decentralized and Centralized Finance aims to achieve the same goal. They plan to make crypto trading popular and improve the trading volume. However, the way these two ecosystems carry out their objectives is different.

CeFi promises security of funds and fair trade on those funds. Investors with conventional currency can also take part in crypto trading. Moreover, CeFi exchanges provide them with customer support services that Defi services do not offer. On the other side, Defi wants to make the space intrusion free. It provides a space for investors to implement their strategies without dealing with an intermediary body.

Both of these models have their pros and cons. It depends on the investor and their needs. Defi is the suitable model to choose from if you prefer transparency and privacy. On the other hand, if your priority is trust, sharing of risks, flexibility, and increased investment options, you should opt for CeFi.

Hope you had a fantastic reading

How a Decentralized Exchange Works | Gemini. https://www.gemini.com/cryptopedia/decentralized-exchange-dex-crypto

DeFi vs CeFi | Decentralized Finance vs Centralized Finance. https://www.leewayhertz.com/defi-vs-cefi/

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DigiEx by Shondy Sainthea

I'm Shondy Sainthea and I welcome anyone to come learn with me about Blockchain,Digital assets and technology.(educational purposes only)