12 min readThis guide is designed to explain the difference between DeFi and CeFi, and highlight each of the various pros and cons they offer. At their core, they both provide access to financial services, however, one is done solely through cryptocurrency industry related blockchain technology.
Here is more on all the various features, definitions, and differences the two types of extremely different financial services have to offer.
The term DeFi is quickly gaining popularity, but not everyone understands what the emerging technology is, how it works, or how it compares to centralized finance, aka CeFi.
With the emergence of Bitcoin and blockchain technology has come come various sub-sectors of the cryptocurrency industry. These include NFTs, DeFi, stablecoins, copy trading and more.
DeFi, or decentralized finance is a broad term that defines cryptocurrency-based protocols that allow for permissionless lending and borrowing, and other services that resemble what traditional banks offer.
CeFi refers to centralized financial services like banks and traditional payments providers. CeFi and DeFi offer many similarities, yet how these features are achieved are vastly different and unique to each technology.
What Is Centralized Finance? What Does CeFi Mean?
CeFi means “centralized Finance.” Centralized finance refers to a financial institution, financial product, or service that is routed through an intermediary. The term is broad sweeping and describes everything from banks to payment providers like PayPal and Venmo.
Many people confuse CeFi platforms like PayPal, Venmo, or Cash App to be DeFi, however, this is incorrect. These applications and services are digital finance, but are not decentralized finance as we’ll explain later.
Advantages of CeFi
The primary advantage of the CeFi sector is trust and history. The risks of CeFi are therefore much lower than their DeFi ecosystem counterparts. There are also a lot more CeFi users across all the existing centralized banking services available today
Many traditional financial services also are insured and provide protections and advanced security. Using CeFi is also as simple as driving to any bank or visiting a digital payments provider website or using an app. There’s also customer support should something go wrong, which doesn’t exist for DeFi users.
Disadvantages of CeFi
Centralized finance is known for high fees, lengthy credit checks, and very low interest rates on any yield generating accounts. For example, the average CeFi savings account provides roughly a 0.03% rate of return, which is meager by any standards. Of course this varies across each CeFi platform.
Existing banks are associated with fiat currencies and are a necessary evil for fiat conversion to crypto assets. Many individuals don’t trust central banks and other traditional financial institutions, while others wouldn’t think of trusting anything but.
What Is Decentralized Finance? What Does DeFi Mean?
DeFi means “decentralized finance.” Decentralized finance is a disruptive new technology based on blockchain networks and involves crypto assets. DeFi services range from permissionless lending and borrowing, to APY-generating yield accounts and much more.
DeFi lets users interact with decentralized applications or Dapps through smart contracts stored on the Ethereum blockchain. With DeFi, users can also lock up assets to earn a reward incentive, gain governance privileges and voting rights, and much more.
Advantages of DeFi
With DeFi, rather than a bank taking custody of your capital, DeFi users trust that their funds are safer in an account they custody and control. With the user retaining their private keys, there’s no risk of seizure, a hack, or other issues related to centralized cryptocurrency exchanges.
This also means that there’s no need to deal with any human representatives at the bank or be subject to credit checks with CeFi and DeFi cuts out all middlemen.
Disadvantages of DeFi
DeFi protocols aren’t yet very initiative or user friendly to use, and often requires technical skills to connect wallets to the blockchain using smart contracts.
DeFi is still young, and an emerging technology which makes the assets associated with each protocol more of a speculative asset. DeFi protocols have also suffered a lot of hacks and liquidity issues over the last several months.
DeFi vs CeFi: Similarities
Both DeFi and CeFi offer users a way to access much needed financial products and services, such as loans, or yield and interest accounts. Both systems function with the goal of generating fees and revenue from users, however, where that revenue goes is ultimately different.
DeFi and CeFi services both include ways to loan or lend money, or generate an interest rate of return on any holdings that are locked up. In traditional finance, money is locked up in accounts called certificates of deposit and typically come with a term. With DeFi locked coins can be unlocked at any time,
DeFi vs CeFi: Differences
At a centralized “CeFi” cryptocurrency exchange, for example, the exchange provides liquidity sources for traders to access. DeFi trading platforms, also called automated market making platforms like Uniswap, instead allow the users to provide the liquidity through liquidity provisioning.
Liquidity providers lock up tokens in a smart contract and users trade those assets within a trading pair. With a CeFi platform the fees generated go to company profits. But with DeFi, due to there being no intermediary, the fees are distributed to users as rewards in the form of a variable APY.
But that’s just the tip of the iceberg when it comes to comparing CeFi and DeFi.
Controllability
CeFi and DeFi are nowhere on the same level when it comes to controllability. With DeFi, the user has complete control and therefore responsibility over their assets and any financial outcomes.
With CeFi, users get almost no control and the bank or institution is in charge of everything from the fees to what happens to your money. If they feel necessary, they can block your transactions, freeze your account, or worse. With DeFi there’s none of that due to there being no intermediary or third-party.
Decentralized Transactions
Decentralized transactions means that transactions are not controlled by any intermediary, and therefore are accessible at any given time. For example, if a CeFi user wanted to get a loan at midnight on a Friday night, they would be out of luck and stuck waiting until Monday when banks open.
With DeFi and decentralized transactions, anyone can access the protocol at any given time due to there being no intermediary.
Permissions
The fact that DeFi is permissionless makes decentralized finance especially attractive. Many users in the world don’t have access to a strong economy or job market, and could have poor credit or low cumulative wealth. This could result in CeFi platforms turning this individual away from accessing products or services.
Banks deny users for poor credit checks, or lacking the initial deposit of funds necessary to get started. With DeFi, however, there’s no permission to consider. Simply click and access the protocol via the blockchain.
Innovation
Clearly, one sector is much more innovative than the other. CeFi has been the same system for the last 50 or so years, with very little changes in terms of new products or services. There’s been the debut of debit or credit cards, and payments providers like PayPal and Venmo, but within the deeper banking system and traditional finance it is the same old.
The industry takes an “if it ain’t broke, don’t try to fix it” approach but it has resulted in a slow and archaic system dominated by bad actors. DeFi is built from cryptocurrency and blockchain technology and is destined to be the future of finance.
Trust Factor
Trust is a mixed issue when it comes to CeFi and DeFi. There is a generation of users who only trust banks and wouldn’t think of putting their money in anything but. However, after the Great Recession and all the bank bailouts, many people became fed up with the broken traditional financial structure, and thus Bitcoin and cryptocurrencies were born.
Decentralized protocols like Bitcoin or DeFi work without an intermediary and removes trust from the equation entirely. People tend to not trust what they don’t understand, and the fact people don’t trust the likes of Bitcoin is solely connected to the fact they don’t quite get it yet or how it works. Trust isn’t a factor at all, and the protocol follows the mathematical and executable code. Cryptography prevents the code from being altered in some way, making trust again a non-issue.
What To Expect In DeFi Vs CeFi In The Future?
The gap in the primary factors outlined above are bound to continue to widen exponentially, until the two services are no longer at all on the same playing field. At the current moment in time, DeFi is slightly dangerous from a technology perspective. If you don’t know what you are doing, there’s a lot of risk as even the likes of Mark Cuban recently found out when he was part of a large DeFi rug pull months ago.
CeFi will continue to die a slow death due to the changing of the guard that’s currently ongoing. Any traditional CeFi institutions will have no choice but to either begin or continue to further adopt cryptocurrency technologies like Bitcoin, Ethereum, or DeFi.
CeFi platforms like PayPal, Venmo, Cash App, and many more are all now offering cryptocurrencies as part of their products and services, and more. More will follow suit. Wall Street will be forced to tokenize stocks, commodities, and other financial products via smart contracts.
DeFi will continue to grow and explode as it has been, attracting more and more users of all kinds. Everyone from institutions to users in poor countries who don’t have access to normal banking services are interested in the booming sector.
There’s bound to be many more disasters along the way, many more bear markets in crypto, and more before DeFi ever becomes as widespread as CeFi. However, at one point typewriters dominated computers, but when a better technology comes along it is only a matter of time until it completely disrupts the existing technology, then replaces it.
DeFi vs CeFi: Which to Invest In?
So which is better, DeFi or CeFi? DeFi wins every time hands down, and there’s not a great way to invest in CeFi. You can invest in bank-related stocks, or keep your money in some kind of traditional bank account which adds to their bottom line. But with DeFi you can contribute direction to a protocol’s growth by investing in the asset. The higher prices the more users the protocol will attract, improving conditions like security and liquidity through network effect.
DeFi assets have already brought users astronomical gains, but the emerging technology is still very early and young. Investing now could be like investing in banks before they became what they are today. Some day when DeFi dominates the entire financial market, anyone who gets in now could end up wealthier than they could ever imagine.
At the same time, DeFi could go to zero as a speculative asset, in case of a situation where governments ban cryptocurrencies or some type of hack or rug pull situation like what happened to Mark Cuban.
Author
Risk Disclaimer
