From a crypto-enthusiasts perspective, there are two halves of the financial system. The traditional one and the one backed by crypto. There are now two subspaces formed by two camps of people who are thinking differently about similar issues on the crypto side of things. The decentralized finance (DeFi) camp and the centralized finance (CeFi) camp. Here is how it happened:
One of the main ideas that govern how cryptocurrency is used is the peer to peer network on which it was created. The original idea was to create a network that doesn’t require middlemen such as a financial institution to moderate it. However, things weren’t as simple. There are essentially two ways you can get cryptocurrency. By either exchanging it with fiat currency or receive your payments in crypto. Depending on how you intend to use this currency, you will likely end up in one of two camps; the DeFi or CeFi camp.
What is CeFi?
As the name suggests, centralized finance means a system whereby a trusted third party is entrusted with funds to keep safe and manage appropriately. People who are comfortable with this arrangement mean that they have placed their trust in the third-party expecting that they will uphold very high ethical standards as seen in traditional finance. Centralized finance in cryptocurrency has evolved to a point where it is clearly an extension of the conventional financial system but with the capability to the people’s more immediate needs that are being ignored by the other financial services. The model for CeFi has been refined to a point where companies such as Binance and Coinbase have been able to properly leverage the structure to help millions buy and sell cryptocurrencies and turn a profit. Some stable coins such as Libra and USDC also fall into the CeFi category because they have a one-for-one US dollar backing. To replace traditional fiat banks in the lending and savings sector, we have platforms such as Celsius, BlockFi, and Pokket. These ones are categorized as CeFi projects because they keep in their custody the private keys to your digital assets.
What about DeFi
The founding principle behind DeFi is to implement 100 percent decentralization onto the finance and cryptocurrency ecosystems. One of the main differences between the two is that DeFi is open source while CeFi is not. Open source projects do not require permissions. Anyone with internet access is free to contribute. As such, DeFi transactions are trustless and permissionless, leaving the duty of care with the users entirely. Unlike in CeFi, where the company stores your private keys for you, here users are all responsible for their own. This leaves them with a level of exposure that’s not there on the other side.
Hackers have found out that such a system is a bit easier to target and have since stolen more than $98million in crypto from January to October. Today, one of the most popular DeFi services deals with decentralized exchanges such as dYdX and Uniswap and algorithmic lending services such as bZx and Compound. These do not require a human to authorize or decline a loan.
Benefits of CeFi and DeFi
Both approaches have their benefits, and how they are improving the world of cryptocurrency every day. For CeFi, one of its most significant impacts is on risk-transference. Once you’ve entrusted your digital currency with them, you can be sure that it’s safe and secure. What’s more, the interface is much more intuitive, meaning better customer interactions. As for DeFi, non-custody of funds is a huge plus. They don’t need to go through a complicated process to get their funds, leaving their funds free to trade, swap and even lend them to someone else for a fee.
What to expect in the future
Both the CeFi and DeFi are in their early stages. As time goes on, so will innovations and inspiration in this sector. Issues such as hacks, security leaks, usability, and volatility, among others, will soon be addressed. As these industries continue growing, traditional banking, as we know it, will come to an end.