The Differences Between Centralized Finance (CeFi) & Decentralized Finance (DeFi) Service Companies
By now, you’ve probably noticed that there are differences between the traditional (fiat) currency and cryptocurrency. Although just emerged over a decade ago, cryptocurrency has branched out to many different classes. Two distinct branches within blockchain-based crypto finance are centralized finance (CeFi) and decentralized finance (DeFi).
In principle, both centralized and decentralized finance have the same goal: to allow people to utilize cryptocurrency in a wide range of financial services. What differentiates the two is how they do it. In centralized finance, the asset class and processes are managed by people or companies. In decentralized finance, they’re managed by a set of smart protocols. The question is: would you trust a company or a set of codes with your crypto assets?
What is Centralized Finance (CeFi)?
Centralized finance is a type of financial practice within the cryptocurrency sphere where users can earn interest and get loans on their digital assets such as Bitcoin, Ethereum, USD Coins like USDT & USDC, and so on, through a centralized platform. The platform can be managed by a person, a group of people, and usually within the jurisdiction of a financial technology (fintech) company.
In centralized finance, the assets and services offered are managed by people, and users need to come to terms with that. It’s about trusting the people or organization behind the platform. Also, CeFi platforms like Hodlnaut are custodial, which means we take user deposits and manage the accrual and payment of interests.
The Advantages of Centralized Finance (CeFi)
Although DeFi gets a lot of spotlight due to its innovative and avant-garde approach, centralized finance has quite a few benefits worth to make the headlines. CeFi tends to offer a more holistic approach and focus on maximizing the value of cryptocurrencies. In general, CeFi platforms are more flexible and convenient compared to DeFi; you can do fiat to crypto conversions and cross-chain exchange. You’ll also get higher interest rates when depositing assets on CeFi platforms. Furthermore, users have access to customer service provided by individuals or companies managing the funds in case of issues or troubles with the services.
What is Decentralized Finance (DeFi)?
Decentralized finance is a financial service that utilizes a set of smart contracts and algorithms to execute its services. The contracts are automated agreements that don’t require intermediaries or banks. They run on the Ethereum network and use blockchain technology. DeFi platforms like Compound Finance are non-custodial, which means users deposit their funds to be managed by smart contracts. No company or individual has access to the funds.
The Advantages of Decentralized Finance (DeFi)
Some of the most significant advantages of DeFi are trustless and permissionless. You don’t need to worry about whether the platform will run as intended or not because you can verify the DeFi services by auditing the codes. Besides, you can also use external tools to check if a transaction was executed correctly. With CeFi platforms, you would always need to do a Know-Your-Customer (KYC) verification to access the services.
In DeFi, you don’t need to do a KYC or any kind of identity verification and can start using the services anonymously. Designed to be freely accessible to all parties without discrimination or limits, one of the downsides of DeFi is that it can be misused by the wrong parties to conduct illegal transactions and frauds, even in financing terrorism-related activities.
It’s safe to say that the differences between centralized and decentralized finance are subtle. It all comes down to the question of whether to trust people to manage the crypto funds ethically or to rely on a smart system that is permissionless and open to all. Either way, the emergence of both services signal the positive outlook of cryptocurrencies and how it’ll continue to disrupt the way we define and use money in the modern world.