DeFi vs CeFi — Understanding the Differences

Featured in Guides

DeFi vs CeFi — Understanding the Differences

Mar 23 2021

Image: Tierney / Adobe Stock

In brief

  • DeFi and CeFi differ in a lot of things, including the possibilities that they offer, as well as what they require.
  • CeFi offers security and advanced services, but it requires trust and the ability to control users’ money.
  • DeFi offers decentralization, freedom, and ownership of funds, but it still lacks a lot of CeFi aspects.
  • DeFi is still quite young — only a fraction of CeFi’s age, so there is time to solve this and offer similar or better features.

CeFi and DeFi are two approaches to digital finance, and while they aim to offer the same result — they approach it from two completely different angles.

The last several years have seen a change in how people access and use financial services. Traditional financial services, such as making payments, or borrowing money, or simply owning a savings account, were not possible without the assistance of a financial institution. So, if you wanted to make a payment or get a loan, you had to go to the bank.

Banks, and similar financial institutions, are centralized, and therefore they had total control over their users’ money. They could decide on the fees or conditions for getting a loan in the first place, and clients would have to comply if they wanted to be serviced.

The rise of cryptocurrency in 2017, when they finally became known to a broader audience started to change things. People no longer needed the banks to make payments — they could simply do it via crypto. But, other financial services were still only available in the banks. Developers took care of that also, and made them available in the crypto sector, as well, often operated by exchanges.

However, despite this, they were still centralized, and so they had yet to become available in the true spirit of crypto. With the rise of DeFi sector last year, this has finally happened. But, the technology is still not perfected, and there are certain flaws, which brought the question of DeFi vs CeFi — decentralized finance vs centralized finance.

Today, we aim to compare the two and see which is better.

What are DeFi and CeFi?

As mentioned, DeFi, or decentralized finance, exploded last year, in 2020. However, before it, CeFi was the standard for crypto trading. The CeFi portion of the crypto industry is still undeniably in the lead, and it revolves around handling crypto trade orders through centralized exchanges. There are many centralized exchanges to choose from, such as Binance, Coinbase, BitMEX, Bittrex, Gemini, and many others.

The point is that the centralized exchanges offer the technology for handling transactions, and users had to use them in order to have their funds processed and sent to other people, their own wallets, and alike. What this means is that people don’t own the private keys, and so that they are, once again, not in control of their money.

Instead, the exchanges have simply replaced the banks. Sure, thanks to crypto, payments are much faster and cheaper, but having someone else in control of your funds is still not what the crypto industry is about.

Then, DeFi emerged, offering a wide range of completely decentralized services. Things like decentralized exchanges, staking, yield farming, lending/borrowing, and more have all immediately become available. Best of all, the user gets to control their own money this time. If they need to use an exchange, they get to keep hold of their money and trade directly from their own wallets, which allows them to keep hold of their private keys, and be the sole owners and managers of their funds.

Furthermore, DeFi also offers a fair and fully transparent financial system, it is very inclusive, as it allows unbanked people to access banking and financial services, and join the global economy via blockchain.

DeFi is building a permissionless, transparent financial service ecosystem, that is also open-source and available for inspection.

DeFi vs CeFi

DeFi - Decentralized Finance and cryptocurrency hashtag, stock m
Image: Max Roquer / Adobe Stock

When comparing DeFi and CeFi, there are many services that are the same. It didn’t use to be that way, as DEXes, for example, did not have the liquidity that would make them equally good as CeFi. However, this changed over the past year, and the two are now relatively similar in this aspect. In the end, it all comes down to whether you trust technology or the people, with DeFi being tech, and CeFi depending on the good will of those who operate exchanges.

CeFi offers centralized exchanges, flexible fiat conversions, and cross-chain services as its largest features. Centralized exchanges are something that we already talked about, but things like fiat conversion is something that is currently not available in the DeFi sector. Exchanging crypto for crypto is not a problem. Exchanging crypto for fiat, however, is, and it usually takes a centralized entity to do so. This is one place where CeFi clearly leads.

Another is supporting trading of various project issued on different, independent blockchains. DeFi also cannot offer this, as it doesn’t have centralized authority. CeFi does, and it can simply get the custody of funds from multiple chains, and then offer them on its platforms.

However, that doesn’t mean that DeFi doesn’t have its own features, that are otherwise unavailable on CeFi.

For example, it is permissionless, meaning that there are no KYC procedures to complete in order to trade. Users also don’t have to share their personal information, or even deposit money, since they can trade from their wallets directly, as mentioned.

DeFi is also trustless, meaning that users do not have to trust that the platform will perform as promised. Instead, they can simply inspect their code and use tools like Etherscan to see how they are performing.

Next, another major advantage of DeFi is the ability to quickly change and come up with new and innovating solutions that expand their capabilities, and experiment with new ones. As a result, they can create a rich ecosystem of advanced features and functionalities. Best of all, with each new function, DeFi becomes stronger and more advanced. It has the potential to rise and oppose not only centralized exchanges, but the entire banking sector.

Final Thoughts

In a way, DeFi and CeFi are the two sides of the same coin. They strive to reach the same goal, which is to make crypto trading possible, popular, and better than what traditional finance has to offer. However, they approach this goal in different ways.

CeFi offers the security of funds, fair trade, customer support, crypto-to-fiat trades, and more. But, it requires users to trust the platforms and give them the ability to manage and hold their money, which is a clear downside of the system.

DeFi, on the other hand, doesn’t require this, but it also doesn’t offer some of the CeFi sector’s benefits and functionalities. It has its own features and benefits, as we have seen, but that it not yet enough to become bigger than CeFi.

But, with that said, it is important to remember that CeFi exists for over a decade, while DeFi has been popular for only around 9 months. True, DeFi has been around for much longer than that, but no one really paid attention to it, apart from a handful of developers.

These developers are the reason that DeFi reached its breakthrough, however, so their work is still extremely important for the sector. But, DeFi only became big in June 2020, and as such, it has only scratched the surface since then and now. Once it reaches its full potential, there is no telling how big it can become, and what possibilities it will be able to offer.