One of the most notable trends of recent years is the development of the decentralized finance market or DeFi. The main rival for DeFi, as it is easy to guess, is centralized financial institutions, or CeFi. Decentralized finance presents new opportunities and challenges for traditional banks and financial institutions. The debate over which system works more efficiently has been going on for years. In this article, we will delve into the main advantages and disadvantages of CeFi and DeFi.
Let’s define the basic concepts: CeFi and DeFi
Centralized Finance (CeFi) is a traditional system of financial institutions such as banks, brokerage firms, and insurance companies. CeFi is controlled and regulated by government agencies. Centralized entities are also called platforms operated by one or more central authorities that provide access to the digital asset market.
One clear example of such a platform is the largest crypto exchange, Binance, where its owners control the entire trading infrastructure. The management of Binance can selectively freeze or restrict the accounts of its customers if they receive a specific request from the government of a particular country.
Decentralized Finance (DeFi) is a trend that uses blockchain technology to create financial applications and services without intermediaries. The principles of DeFi include decentralization, and full automation based on the operation of smart contracts. DeFi’s philosophy involves doing away with centralized instances and intermediaries to evenly distribute responsibilities among market participants.
Instead of banks in DeFi, loans are issued by the users themselves, who want to capitalize on their assets. An example of such a system is the AAVE platform. This is one of the most famous financial platforms that provides services of lending and earning on cryptocurrencies.
Let’s analyze the advantages and disadvantages of CeFi
Advantages of CeFi:
Security: centralized financial institutions have years of experience in securing and protecting clients’ assets. In addition, centralized platforms are often backed by the laws of the countries in which they operate.
Liquidity: CeFi provides high liquidity, which means clients can easily buy and sell assets.
Centralized structure: the main disadvantage of CeFi projects is their centralized structure. In these projects, control of the platform and user assets is in the hands of a small group of managers who can make decisions according to their interests.
This approach also leads to a loss of anonymity for users.
Limited access: Some groups may face restrictions in accessing financial services due to client requirements or regional restrictions.
Let’s analyze the advantages and disadvantages of DeFi
Advantages of DeFi:
Affordability: DeFi is available to all users irrespective of their geographical location. Also, to get a financial service on DeFi, the user doesn’t need to provide income certificates or leave their home.
Transparency: all transactions in DeFi are recorded on the blockchain and are available for public viewing, which ensures high transparency.
Decentralized management: in the DeFi market, price dynamics are determined by market participants. They are forced to respond to changes in demand themselves. Traditional banks can set prices, focus solely on their interests, and are subject to central bank regulation.
Anonymity: in the DeFi market users can keep their data private.
Disadvantages of DeFi:
Security: the main disadvantage of DeFi is the lack of security. Incidents of protocol hacking in the decentralized finance market are quite common.
Market volatility: the DeFi market is often more volatile than traditional markets, which can lead to large financial losses.
Each of the two «financial worlds» has both strengths and limitations. In the young and innovative DeFi, there are no intermediaries, but the level of security is not at the highest level. CeFi is controlled by government authorities, but offers convenient transaction tools and provides a high level of security.
It is likely that in the near future both financial approaches will combine elements of each other.