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With the inventive power of blockchain technology, ideals around payments, lending, and borrowing have shifted in recent years. The expansion of cryptocurrency began a new era of considerate discussion about decentralized finance (DeFi) and centralized finance (CeFi).
While CeFi typically refers to products and services provided by centralized institutions like banks, DeFi refers to decentralized financial institutions, such as financial applications built on blockchain. DeFi apps are powered by smart contracts, eliminating the need for a middleman or central authority.
What is Decentralized Finance? (DeFi)
DeFi, or decentralized finance, is the product of the shift from traditional centralized financial systems (CeFi) to peer-to-peer finance enabled by decentralized technologies. It is an umbrella term encompassing all decentralized financial technology, including security protocols, connectivity, software, and hardware, that uses distributed ledger (blockchain) in its operations.
DeFi applications are powered by smart contracts, which are self-executing computer protocols that automatically enforce the terms of a contract once certain conditions are met. This means that DeFi apps don’t require a third party, like a bank, to act as a middleman.
DeFi applications are powered by smart contracts, which are self-executing computer protocols that automatically enforce the terms of a contract once certain conditions are met. This means that DeFi apps don’t require a third party, like a bank, to act as a middleman.
What is Centralized Finance (CeFi)?
CeFi refers to traditional financial systems that are centralized, meaning they are controlled by a central authority. CeFi products and services are provided by traditional financial institutions like banks, which act as intermediaries between two parties in a financial transaction. CeFi systems are also centralized because they require trust in the centralized entity to hold and manage customers’ funds safely.
What is the difference between DeFi and CeFi?
The key question for users when comparing DeFi and CeFi remains: who to trust, technology or people?
With DeFi, users retain control of their own funds at all times. DeFi apps are built on blockchain, for instance, Ethereum, which is a decentralized network of computers that anyone can access. This means that there is no single point of failure and no need to trust a centralized entity.
In contrast, CeFi systems rely on centralized institutions like banks. This means that users must trust these institutions to hold and manage their funds safely. If the bank were to experience an outage, for example, customers would be unable to access their funds until the issue is fixed. This is not the case when using DeFi technology, as transactions can be verified through various nodes.
The DeFi ecosystem is still in its early stages, with a number of projects still in development, while the CeFi system has been in place for centuries and is much more developed. DeFi projects are therefore trying to build trustless alternatives to traditional financial products and services.
Features of Centralized Finance (CeFi)
CeFi products and services are provided by centralized institutions, which act as intermediaries between two parties in a financial transaction. These institutions include banks, credit unions, and other financial service providers. CeFi systems are centralized because they require trust in the centralized entity, for instance, a bank, to hold and manage customers’ funds safely. As we have already explained, their centralization also means they rely on a single point of failure.
Some examples of CeFi products and services include
- Banking services: checking and savings accounts, loans, credit cards.
- Investment products: stocks, bonds, mutual funds.
- Insurance products: life, health, auto, homeowners.
- Payment systems: debit and credit cards, ACH transfers.
- Government benefits: Social Security, Medicare, Medicaid.
Features of Decentralized Finance (DeFi)
DeFi is a broad umbrella term used to describe peer-to-peer financial technology enabled by blockchain.DeFi applications are powered by smart contracts, which are self-executing computer protocols that automatically enforce the terms of a contract once certain conditions are met. This means that DeFi apps don’t require a third party, like a bank, to act as a middleman.
Some examples of DeFi products and services include:
- Lending and borrowing platforms: MakerDAO, Compound, dYdX.
- Decentralized exchanges: Uniswap, Kyber Network, 0x Protocol.
- Asset management: Set protocols, Melonport.
- Payments and invoicing: Connext, Dharma.
- Identity and reputation: uPort, Civic.
Conclusion
CeFi is more convenient because of its faster transactions and easier-to-use interfaces. DeFi has the potential to be more secure because it minimizes trust in central points of control. However, the novelty of this technology can be its downfall, as many users don’t understand how to use DeFi products.
It will likely take a few more years for DeFi to catch up to CeFi in terms of an overall number of users, but as the space matures, we will start to see more projects that offer both convenience and security.
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