For decades, the traditional financial system, also known as Centralized Finance (CeFi) has been adopted across the world. However, the revolution of the Internet and the rise of Web3 gave birth to a new financial system: Defi, short for Decentralized Finance. DeFi is now gaining popularity with investors who are wanting better control of their sovereign wealth. . Similar to conventional (Fiat) Vs crypto (read here), DeFi & CeFi are two major subways for blockchain-based financing.
What is DeFi (Decentralized Finance)?
DeFi is a blockchain-based form of finance that does not rely on central financial intermediaries to offer services. Instead, it utilizes smart contracts on blockchains. A smart contract is an automated code that runs on the blockchain and cannot be changed. Defi offers several services like trading, insurance, lending, issuance of money, staking, payments, financial data, over-the-counter (OTC) trading, asset management, and more.
What is CeFi (Centralized Finance)?
CeFi or Centralized Finance is where you trust centralized companies like crypto exchange platforms to store your funds and manage services.
Most of the CeFi service providers have a Know Your Customer (KYC) and Anti Money Laundering (AML) policy in place to comply with the jurisdictions’ rules. It means that you have to share your personal information with them and ensure that your funds are not coming from or will be used for any illegal activity.
Key Differences between DeFi & CeFi
Although centralized finance and decentralized finance focus on the same thing — increasing the adoption of blockchain in the world, there are some crucial differences that lie between both.
1. Custody of funds
Unlike CeFi where the specific exchange platform holds asset custody, DeFi gives their customers complete control over their assets. Examples of DeFi exchanges include — pancakeswap, sushiswap, coinbase, etc
Although CeFi does its best to maintain complete security, there have been multiple instances of breach around CeFi-based cryptocurrency exchange platforms. The biggest and most recent examples of such security breaches include FTX, Binance and Bitmart. In the case of DeFi, the only thing users have to care about is paying attention to the code and the consensus algorithm used in the decentralized finance project.
3. Personal Information
Most CeFi providers have a mandatory KYC policy, where the person’s identity is verified and stored with the platform. With a DeFi platform, KYC may not be required to access all products and services. This is good news for users who do not have access to proper documentation such as passports and IDs — specifically in regions within Africa and Asia and other underdeveloped nations.
4. Risk Factor
With CeFi, the exchange or platform bears the responsibility for complete security, and cyber-attacks whilst the security depends on the blockchain itself in most DeFi products.
Although both CeFi and DeFi are very similar concepts, their approach is very different.
In centralized finance, individuals or businesses are in charge of the asset class. On the contrary, in the case of decentralized finance, it is controlled by a group of decentralized protocols. We hope this blog helped you establish their key differences, advantages, and disadvantages. Assess each point to better understand which option is better for you and money. And, of course, DYOR.