Cryptocurrencies introduced the world to a decentralized financial system model through blockchain technology. While cryptocurrencies serve the purpose of both a fungible currency and a tradable asset, it is the blockchain that has made it possible for it to be accessible to all. This multi-functionality of blockchain prompted the existing financial industry to adapt around the technology creating a world of financial services centric to it.
Now, this world of financial services of cryptocurrencies and blockchain can be broadly demarcated into two categories. These are Decentralized Finance (DeFi) and Centralized Finance (CeFi). While both these categories serve to achieve the same objective, they tend to differ in the path to achieve it. Let’s start with their definitions.
What is DeFi?
Decentralized Finance, abbreviated DeFi, refers to the application of a decentralized network to avail financial services like trading, loans, derivatives and likewise services. DeFi does not involve any intermediary in the form of a person or an organization. Instead, the system works on smart contracts and similar protocols that allow the exchange of services between two parties without the involvement of a middle man.
Quick note:- Smart contract is a self-executing programmable code in a blockchain network that executes itself when its underlying pre-agreed instructions get satisfied.
Interestingly, the working of DeFi is in-line with the inherent trait of cryptocurrencies and blockchain, which is the feature of being decentralized. DeFi eliminates the need for banks and financial institutions and simply requires an individual to access the blockchain network and do whatever they like using their funds.
What is CeFi?
Centralized Finance, abbreviated CeFi, is akin to the existing financial industry where an organization or middle man facilitates a financial service such as trade, loan, swap and others, often being the central decision in the process.
The organization provides interface, support and addresses customer grievances. In the crypto world, cryptocurrency exchanges are an example of a CeFi entity where the customer registers on the exchange to avail of its services. So just like real-world financial service entities, a user authorizes a centralized body to use their funds to get the desired services.
Understanding DeFi vs CeFi
One way of understanding the nuances associated with this debate is by first discussing the pros of both DeFi and CeFi, followed by discussing their cons. However, this robs one from evaluating both financial categories simultaneously on a particular parameter. During the following discussion, we broadly analyze the trends and services rendered in both the DeFi and CeFi sectors. Some financial institutions belonging to either sector might differ from the features listed. However, for the scope of discussion, popular trends in both sectors are discussed.
So here is an evaluation of both the services on metrics that matter:
#1 Access to funds
CeFi works on the principle that a user needs to transfer their funds to a CeFi institution. The user can then direct the use of the funds, but it’s the institution that handles the funds. This goes for the cryptocurrencies bought and traded as well. The institution stores the crypto in its wallet, and the user does not have a key to it.
DeFi instead empowers a user to use their funds the way they like. A user simply needs to access the DeFi network, which then gives a serial number to the user for identification. Once on the network, the user can use the funds for anything supported on the network.
CeFi requires a user to register on the exchange by sharing their personal information after going through a KYC process. Thus the institutions can refuse to render their service to a customer. While DeFi simply registers a user irrespective of their identity and from wherever they come (subject to basic conditions).
#3 User Interface
Since major financial institutions and organizations comprise the CeFi sector, they offer easy to navigate and user-friendly interface for the optimum support of the customer. Most DeFi networks lack this trait and hence might appear a bit complex to use at first.
#4 Customer service
CeFi is a competitive space with each exchange and institution trying to lure the customer. Thus customer care service offered by this sector is impeccable, with special departments assigned to tend to customer needs. Again, DeFi networks are independent networks and usually don’t come with customer support services.
DeFi works on the principle of decentralization. Hence the network information right from past transactions, existing members and other crucial information are publicly available on the ledger. CeFi institutions, on the other hand, work behind the curtains simply facilitating the trades.
#6 Fiat conversion
Fiat conversion is a key feature of CeFi entities. One can convert their money to and from cryptos through the institution. DeFi networks don’t offer this type of facility to their members.
#7 Scope of innovation
There is not much to innovate when it comes to CeFi services. However, since blockchain is still at an early stage with ground-breaking advancements taking place routinely, DeFi networks are upgrading themselves at an exciting rate. This leaves more automated benefits for the users.
#8 Cross-chain services
However, most DeFi networks can’t support such a type of trade. Only a few use protocols like ‘atomic cross-chain swaps’ that can exchange one crypto asset for another. But this swap requires coding that can be complicated at times.
#9 Potential threats
A key threat associated with CeFi is the nightmarish hacking of exchanges or other institutions. While exchanges and likewise providers often enlist state-of-the-art security measures to protect themselves, exchange heists still make the news every couple of months.
On the other hand, the biggest nemesis of a DeFi system is the network itself. Any flaw in the line of code or a bug can compromise the assets of the users.
So which one is the better?
Unfortunately, there is not a simple answer to this. Here, the trader needs to introspect his needs to ascertain which features do they value more. If losing control over your funds is a major concern then DeFi comes at the top of the debate. However, transferring funds to intermediate entities is an activity that millions partake in daily while equity trading. So, this should not be much of a concern.
Likewise, if fiat conversion or cross-chain transactions are a crucial part of your cryptocurrency usage, then CeFi presents itself as the most reliable option in the market. Again, as discussed above, atomic cross-chain swaps can facilitate these services in the DeFi ecosystem. You can find the right DeFi network to avail of cross-chain services seamlessly.
Maybe, in the long run, a hybrid blockchain financial system might emerge that will combine the pros of both these financial service categories. However, for now, that is far from reality. So don’t let this confusion of choosing one service over another stop you from trading. Try both of them and then ascertain which is more in line with your needs and demands.
Here’s a guide to get you started on WazirX.
Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn’t represent any investment advice or WazirX’s official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.