The world of finance has been revolutionized to its core. Twelve years have passed since Blockchain made its debut through the advent of bitcoin, the first cryptocurrency. Since then, the financial ecosystem has been gradually galvanized towards a long pending paradigm shift.
If we consider the circumstances that led to the inception of bitcoin, the role of Blockchain in defining this new ecosystem becomes cloudless.
In 2008, the world witnessed one of the most significant economic depression which was caused due to the bankruptcy of the iconic US investment bank, Lehman Brothers Holdings. Shedding light on the breach of people’s trust by central banks and other banks, this economic depression called for a change. A change in the financial ecosystem.
Thence came bitcoin. Just two months after this crisis, bitcoin made its debut, introducing the world of finance to a simple yet powerful concept of decentralization through Blockchain.
But, amidst all the hype, the inclusion of cryptocurrencies in the current financial system is a protracted journey. While bitcoin and other cryptocurrencies have shown unprecedented adoption, the complete control of the financial ecosystem in the hands of every person begs the question,
Is the world truly ready for complete decentralization?
Even if it is,
Is it possible to achieve complete decentralization?
While these questions need a few more years to be answered accurately, those are years we don’t have. What we need is a new financial structure, and we need it now.
Following the path towards Decentralised Finance(DeFi), we need to bridge the gap between the traditional financial system and decentralization. This is where Centralised Finance(CeFi) swoops in.
Let’s take a deep dive into DeFi and CeFi and compare their characteristics to determine the future of our financial ecosystem
What are DeFi and CeFi ?
DeFi or Decentralised Finance is the financial service that depends on code rather than any middle man. In other words, these financial services make use of smart contracts on top of Blockchain technology to automate and enforce financial agreements between two parties without the need of a third party.
The use of smart contracts eradicate the need for trust, regulation, and governance by a third party, and the use of Blockchain creates a transparent ecosystem. Therefore, DeFi has gained immense popularity over the last couple of years.
Ethereum being the first platform to introduce the concept of smart contracts on Blockchain, most DeFi applications are built on Ethereum. Facilities such as flash loans, derivatives, permissionless trading and margin calls, insurance, and much more are available through DeFi. Some popular DeFi applications include MakerDAO, Compound, dYdX, Uniswap, and Balancer.
While DeFi is a revolutionary concept and is shifting the paradigm of Financial applications, it is impossible to replace the legacy financial industry. This is where CeFi comes to the rescue.
Recognizing the powers of Blockchain in the financial sector, the flaws of the traditional financial industry have become too mainstream that incorporating Blockchain in the financial industry has become imperative. A more proper incorporation of Blockchain is CeFi.
CeFi or Centralized Finance is where the end users can reap the benefits of the cryptocurrency world while still depending on a third party. Basically, a user trusts a third party like an organization to store and manage their funds.
Essentially, users can earn interest or get loans based on cryptocurrencies that they own by giving custody to other organizations. These organizations act as lenders and take responsibility for the user’s funds. Therefore, CeFi bridges the gap between the traditional financial system and decentralized finance. The most popular examples of CeFi are Binance, Coinbase, and SALT.
Benefits of using either DeFi or CeFi
At the very core, both DeFi and CeFi make use of cryptocurrencies. The financial system where central banks possessed all the power is being replaced by the inclusion of cryptocurrencies, where every person enjoys the liberty to code their currency.
Yields, speed of transaction, and transparency are the three primary factors driving financial inclusion. While the traditional financial industry gradually improved in all these factors, the advent of DeFi and CeFi have introduced unprecedented upgrades. Better yields as part of yield farming, faster transactions, and a transparent ecosystem are definite with the inclusion of DeFi or CeFi.
Therefore, DeFi and CeFi both are part of the long-awaited financial revolution that marks the end of traditional banking.
While DeFi and CeFi both bring unique advantages to the table, there are a few things that are provisioned by both. Lending and borrowing along with high yields are common to both, and so is the cryptocurrency trading, margin trading, derivatives training, and the use of stable coins.
These benefits make it cloudless that Blockchain inclusion is imperative for the future of finance. However, it still begs the question, which one will become the future of the financial industry, CeFi or Defi?
DeFi vs CeFi – A comparison based on different factors
From the aspect of ownership, a DeFi application is too secured. With DeFi, a user has to trust the technology, and the technology never takes a day off and never makes mistakes.
With CeFi, a user has to trust the people or the organisation. The central authority managing the funds of a user is responsible for all the financial activities such as interest payment.
Another perception for ownership can be that DeFi is a non-custodial approach where the funds are managed by smart contracts, and CeFi is a custodial approach where the user’s coins are in a company’s holding.
With no conditions, no verifications, and no age barriers, DeFi applications are available to everyone. There is no need for documents to verify a user. On the other hand, CeFi applications require KYC. A user has to provide certain documents to verify their identity and use the CeFi application.
After the user has registered on an application, the verification process still differs significantly. In a DeFi application, a user is responsible for maintaining their keys to log in to the application. In CeFi, there is a mobile application with two-factor authentication and push notifications.
CeFi prevails in this aspect. With the utmost flexibility available in a CeFi application, a user can get a loan, borrow or lend, deposit or withdrawal, and above all, leverage the fiat assets to buy cryptocurrencies. CeFi also provisions a wide array of fiat transfer services.
DeFi offers just the necessary financial facilities. The money in DeFi can not be used to pay for bills, taxes, or things in real-life.
- Ease of use
DeFi is where a user interacts with the smart contracts directly. Therefore, to use a DeFi application, a user has to understand the concept of smart contracts and Blockchain to ensure that they are operating the application in the right manner.
While this gives more power to the user, every user is not capable of understanding such technologies. Most users are overwhelmed with such concepts.
CeFi combats this problem by providing a seamless user interface. With advanced UI/UX, CeFi applications are straightforward to use. A user is not required to understand how smart contracts work or how cryptocurrencies work, but the user only has to know how to operate the CeFi application.
- Trust and Transparency
If you are looking for trust, DeFi is what you need. All transactions on a DeFi platform are available to everyone. Everyone owns a unique account id on the DeFi platform, but the identity of a person is never revealed. Therefore, a trustful and transparent ecosystem is what DeFi promises.
In CeFi, every user is required to do a KYC. This means that all the information of a user is stored in a database belonging to the CeFi authority. This can be perceived as limited trust and transparency as the record is maintained by a central authority.
- Fiat conversion
It is no secret that CeFi applications offer greater flexibility and one area where this flexibility can be seen is the fiat conversions. The need of customers varies from time to time and place to place. Therefore, a platform offering decentralised financial services is expected to provide cross-chain exchange and accommodate the different needs of different users.
At present, the conversion of fiat to cryptocurrency and vice versa requires a central authority which is why a DeFi application does not accommodate such conversion needs of users.
- Risk Management
Risk management is the most integral part of any financial infrastructure. In a DeFi application, the use of smart contracts eradicates the possibility of “hush money” or manual errors. Still, at the same time, these smart contracts are not capable of dealing with market situations such as fluctuations, mass liquidation, and more.
With CeFi, a central authority can handle such situations with ease. They can quickly respond to sudden market situations and manage risk efficiently. This helps in minimizing the loss to the users.
Replacing the traditional financial system seems like a far-fetched dream because this is how the financial sector has operated for centuries. There has always been a third party to govern, regulate, and provide authentication to our financial activities. With the advent of the Internet, these financial activities got digitised, but they still had significant drawbacks.
The inclusion of Blockchain and cryptocurrencies seem to be the perfect solution, but the right way of incorporating these technologies is still hazy.
While DeFi has the potential to shift the financial paradigm completely, it is incapable of providing support for the traditional financial system that has deep roots.
Here, a synergy between DeFi and the traditional financial system is what the world requires at the moment. This synergy is CeFi. By providing a central authority to control decentralized finance, CeFi is eventually acting as a catalyst to the adoption of DeFi.
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