What is Centralized Finance (CeFi)?
At the outset, traditional financial services were only accessible at established financial institutes such as central banks and credit unions. There were limited services available, ranging from getting business and personal loans to doing investments.
This changed in recent years due to the development of financial technology (FinTech) which has been created to assist with personal and commercial finance like digital lending and robo-advisors. There is also a growing interest in cryptocurrencies and the advancement of blockchain technology. With the world of cryptocurrency expanding, people seek to understand the current debate about centralized finance (CeFi) vs decentralized finance (DeFi).
To understand further, this article would provide insights about centralized finance along with its advantages and disadvantages.
What is Centralized Finance (CeFi)?
Centralized finance is a financial practice that allows users to earn interest and get loans on their cryptocurrencies through centralized exchanges. To be able to process your desired transactions and crypto orders, private keys to the crypto assets that you own would be entrusted with your chosen third-party entity. The aim of CeFi is to boost speed and cost-efficiency of processing transactions while making fair trades.
Examples of CeFi exchanges include:
With over 56 million verified users, Coinbase is the leading mainstream cryptocurrency exchange. A huge variety of products is offered which includes an advanced trading platform and a wallet for retail investors. Coinbase is on a journey to create a more fair, accessible, efficient, and transparent financial system enabled by crypto.
Founded in 2017, Binance has grown to become one of the most popular cryptocurrency exchanges and is available in more than 180 countries. It has a strong focus on altcoin trading and offers trading in more than 500 cryptocurrencies and virtual tokens which includes Bitcoin (BTC), Ethereum (ETH), Dogecoin (DOGE) and its own Binance Coin (BNB).
Hodlnaut is a Singapore-based fintech startup that provides financial services to individual investors and cryptocurrency enthusiasts. Started in April 2019, Hodlnaut is quickly rising to become one of the most promising crypto lending platforms in Asia. Through its straightforward product offerings and dedicated support, Hodlnaut is on a mission to help hodl-ers get more yield on their digital assets easily.
Benefits of Centralized Finance (CeFi)
1. Higher Interest Rates
CeFi platforms determine the interest rates by themselves, thus more stable as they are not subjected to market forces. Interest rates also tend to be significantly higher as compared to DeFi platforms.
Interest rates were last retrieved on 31 May 2021
2. Flexibility in Fiat Conversions
Conversions between cryptocurrency and fiat normally require a centralized exchange. People who are new to trading crypto can conveniently use such exchanges to convert fiat to crypto and vice versa. This cannot be easily done in DeFi. Therefore, in this aspect, CeFi trumps DeFi with the seamless experience.
3. Cross-chain Services
Centralized finance systems support the trading of different coins that are issued on independent blockchain platforms. However, DeFi systems are more restrictive and do not support such tokens due to the elaborate and cumbersome process of performing cross-chain swaps. This is a significant advantage of CeFi as most of the high market-cap coins are traded on independent blockchains.
4. Availability of Customer Service
Blockchain technology is a rapidly developing field and investors might find it challenging to keep themselves updated. Well-established exchanges have efficient customer service departments to assist during uncertainty. Additionally, they tend to provide easy access to vast knowledge on crypto to educate their users, for example, Hodlnaut Resources that cover topics across the entire DeFi ecosystem, from interest accounts to loans and borrowing and guides for using cryptocurrencies.
Risks of Centralized Finance (CeFi)
1. Risk of Compromised Privacy
The initial process of creating an account with a centralized exchange includes giving it private details such as your legal documents and residential address. This process is commonly referred to as KYC (Know Your Customer) and it helps to prevent illegal activities like money laundering by verifying that the users are real. If the exchange encounters a cyber intrusion, there is a risk that your private information may land into wrong hands.
2. Risk of Losing Funds
In CeFi, users entrust their funds to their chosen centralized exchanges and have no autonomy over their funds. Essentially, we are trusting the people managing the businesses to uphold a high level of security and protect the assets. If the exchange is hacked, there is a high possibility of losing them.
Despite these risks, you need not be worried about CeFi as almost all exchanges utilize blockchain forensics and have companies to keep a look out for any fraudulent activity. They aim to reduce any risks and protect their customers, providing a reliable environment.
Centralized Finance (CeFi) vs Decentralized Finance (DeFi)
Both CeFi and DeFi platforms advocate for the adoption of blockchain and digital currencies and have the same end goal i.e. to assist people in using crypto for various financial needs and services. What sets them apart is their approach in attaining this goal.
CeFi provides higher interest rates and increases trust and flexibility with customer service, flexibility in fiat conversions and cross-chain services. While DeFi increases privacy and security by removing the need for any third parties. Both use contrasting methods to reach the same objective.
In conclusion, each system has its own pros and cons and plays an essential part in cryptocurrency. The future is bright for both CeFi and DeFi, and you could always diversify your portfolio by using both services instead of settling on one. Before anything else, you must first determine what are your current priorities and do your due diligence before deciding your next step.