This article aims to provide an overview of the differences between Centralized Finance (CeFi) and Decentralized Finance (DeFi). It references cryptocurrencies and the BNB Chain. If you are unfamiliar with DeFi, check out our other Learn DeFi articles for more educational content.
The Rift Between CeFi and DeFi
From a total value locked (TVL) of US$670.77M in 2019 to US$240B at the end of 2021, the DeFi boom in the last four years cannot be ignored. The construction of decentralized Layer-1 and Layer-2 architecture has culminated in the exponential increase of DeFi use cases.
CeFi institutions offer crypto investment opportunities with ease of use and reliability adapted from TradFi products and services. They are indispensable in the Web3 world, facilitating most global crypto transactions, and serving as a conduit for fiat-crypto conversions, making them the bridge between TradFi and DeFi.
However, centralization presents issues such as opacity and access to users’ confidential information. CeFi institutions can restrict access to user services and misuse funds without users’ acknowledgment. “Not your keys, not your coins” has become the cry of the DeFi community, summing up the push towards decentralization. In reality, there remains a jarring chasm before this utopian future – CeDeFi offers a solution.
CeFi vs. DeFi
CeFi and DeFi have different benefits and drawbacks which are crucial to understanding CeDeFi and its significance.
In CeFi, users must have complete faith in the central entities’ competency and intentions where they call the shots for everything—from onboarding users to managing assets.
In DeFi, however, users can perform peer-to-peer (P2P) transactions and access financial services without trusting a single entity. For instance, users can monitor transactions of decentralized applications (dApps) through a code audit or by employing external tools such as Etherscan or BscScan. While a dApp’s code may not always be open-source, its execution and bytecode must be made public and verifiable on a blockchain to be classified as non-custodial DeFi. dApps aim for decentralized ownership, where each user in the community has a say in how the application is maintained, and this is less prioritized in CeFi.
The early days of the 2022 Crypto Winter shed light on the irresponsible use of funds and the participation in unsecured deals by centralized institutions such as Three Arrows Capital (3AC) and Celsius. 3AC and Celsius eventually became insolvent, causing massive losses on the part of investors who have placed their trust in them. These incidents prove the importance of transparency.
Custody of Assets
In CeFi, custody of assets is entrusted to centralized exchanges (CEXs). Users typically hold their crypto in custodial wallets with private keys held by the CEXs. On the other hand, DeFi users have full control over their private keys and full custody of their own assets.
CEXs are entrusted with users’ information and assets, and users must have complete faith that the advanced security measures will protect their crypto against all malicious attacks, which is not always true. However, utilizing a CEX often comes with the perks of customer support and the possibility of retrieving misplaced assets, which is impossible in DeFi.
DeFi users are fully responsible for their crypto holdings. While this aligns with the ethos of DeFi, it means that users bear the full risk of losing their assets. Seed phrases of a non-custodial wallet can get lost or destroyed, and because dApps operate fully on the blockchain, there is no central entity that can help users to recover lost funds.
While it is harder to carry out a crypto attack due to decentralization , dApps and crypto wallets are not entirely safe from attacks. Many bad actors carry out malicious acts on unsuspecting participants in the space for various reasons, such as stealing funds or simply taking down networks. Identifying the perpetrators and bringing them to justice is no easy task when a network is compromised.
Privacy is also compromised in CeFi because there are often stringent know-your-customer (KYC) and anti-money laundering (AML) policies that users must adhere to. This gives companies access to important private information that links users’ real-world identities to their crypto holdings. In an extreme scenario, companies may misuse this information to their advantage.
CeFi and DeFi also differ with regard to usability. Due to infrastructural infancy, DeFi users are often required to understand various technical jargon and navigate multiple interfaces, making the user experience unintuitive and unenjoyable.
CeFi services can offer high-quality customer support. When mishaps such as wrongly transferred funds occur on CEXs, users can contact their customer service directly to resolve the errors. Some CEXs even include user insurance. Binance, for example, has built up a US$1B insurance fund to protect its users’ funds from crypto hacks. This gives users a sense of confidence when participating in CeFi.
On the other hand, DeFi only has frequently asked questions (FAQs) and community moderators providing customer support. FAQs address common user issues, while community moderators on social media channels such as Telegram groups and Discord servers try their best to help community members. Although these initiatives help users, the extent of support offered is limited compared to what users can get in CeFi.
CeFi platforms are user-friendly and often support several chains, thus offering cross-chain capabilities that triumph over what is currently available in DeFi. Since the Ethereum network is the biggest DeFi ecosystem, many decentralized platforms require tokens to follow Ethereum token standards to achieve interoperability which is key to the mass adoption of DeFi. Conversely, many cryptocurrencies with high market capitalization and trading volume, such as Bitcoin (BTC) and Ripple (XRP), exist on independent blockchains that lack interoperability prerequisites.
Another benefit of CeFi is fiat-conversion flexibility, which often involves a third party or a centralized institution. DeFi platforms do not offer fiat on-ramps, so users must first convert their fiat to crypto via a CEX or third party before participating.
Nevertheless, DeFi provides much greater accessibility to retail investors than CeFi. The absence of regulatory checks and restrictions imposed by central governments means that everyone, including the unbanked, can benefit from financial opportunities and services in DeFi. The lack of regulation, however, comes as a hindrance to institutional investors with regulatory hurdles of their own that do not align with DeFi platforms.
Summary of Differences Between CeFi and DeFi
|Centralization||CEXs run by centralized entities||dApps run on blockchain|
|Custody of Assets||Entrusted to CEX||Users have complete custody|
|Security||CEXs have full control over users’ funds||Users are fully accountable for their own funds|
|Ease of Use||User-friendly||Less user-friendly|
|Customer Service||Provided by CEX||Highly limited or, at most, provided by community moderators|
|Fiat On-Ramp||Provided by CEX||Unavailable|
|KYC and AML||Users are required to undergo regulatory checks||Absent|
This publication is provided for informational and entertainment purposes only. Nothing contained in this publication constitutes financial advice, trading advice, or any other advice, nor does it constitute an offer to buy or sell securities or any other assets or participate in any particular trading strategy. This publication does not take into account your personal investment objectives, financial situation, or needs. Treehouse does not warrant that the information provided in this publication is up to date or accurate.
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