CeFI vs DeFI: Is DeFI the solution for the future?
The topic of Centralized vs Decentralized is clearly not a new thing as it goes towards every aspect of our lives. But since finance is an essential part of everybody’s well-being, it is one of the most interesting arguments out there. Decentralized Finance clearly stands in between these arguments — although it is loved by the users, governments have a different view on this. So what are Centralized and Decentralized Finance? Can Decentralized Finance be the optimal solution for everyone?
CEFI vs DEFI
A lot of the discussion on CEFI vs DEFI has always been centered around the idea of Authority vs Freedom and this is actually the main idea behind the creation of Bitcoin in 2008. Centralized Finance has been around for generations ever since the creation of money and so far even though it has worked all these times, there are still questions about its sustainability?
Centralized Finance or CeFI as we use to call it involves the centralization of the financial activity in the crypto space through a single organization or institution. CeFI service providers such as Centralized Exchanges will then run its operations such as trading activities in coherence with the local regulations where they operate. These regulations will then make it mandatory for Centralized Financial Institutions to implement procedures like Know Your Customer (KYC) and Anti Money Laundering to make sure that only the right people are on board the network.
CeFI Service Providers will then store these pieces of information and users’ funds in their own custodial wallet which will then be the routing destination for every trading activity going on the platform. These custodial wallets also store your private keys or password and in return, they provide the users with different services such as lending, borrowing, or margin trading. Currently, Cryptocurrency Trading still remains the most well-known solution with giant crypto exchanges such as Kraken, Coinbase, and Binance being common names in the crypto space. It also still remains the most common way for a cryptocurrency to be traded and exchanged currently as it forms a bridge between the regulations and the crypto space.
The reason behind its popularity is because CeFI operates similarly to its traditional counterparts such as the Banks where yields are earned through lending and borrowing and trades are maintained on a limit order books basis just like in the stock market. This singular system then makes it easier for people to follow because they are used to the stock market and form a perfect introduction to the crypto space for new users. They are also able to offer a better variety of trading pairs with better liquidity for the major coin pairings and without these crypto may not be where it is today. Also their coherence to the local regulations and partnership with traditional financial institutions, makes it clear to people that these institutions are on the right side of the law and to then trust it.
Obviously from what we know happens too often that when you give an institution or organization that much control over finance, they then utilize it for their own benefits. This is the main problem with CeFI where the users do not have control over their assets or their funds and trust that the organization will act in good faith but what if they don’t? Look at what happens with Mt. Gox and Thodex just to name a few where billions of investor funds are lost due to the irresponsibility of its executives. These Centralized institutions also have to reflect the constant change in regulations and have control to seize or deny entry to any users that do not adhere to proper legalities.
When we flashback to the idea behind Bitcoin, it was always about creating a decentralized world that is run and built for the community so this CeFI service providers even though its popular clearly do not reflect this. Although Bitcoin introduce the idea behind DeFI, it was Ethereum and its EVM which introduce to a whole new world run by codes.
DeFI or Decentralized finance is a blockchain-based form of Financial service that is both open source and decentralized without any intermediaries. It replaces the role of the institutions with smart contracts which is an automated code that is programmed certain functions in the blockchain and cannot be changed. A transaction happening in a smart contract is processed by the blockchain without any third-party intermediaries.
DeFI is compatible with most CeFI products as DeFI platforms can be integrated for people who want to lend or borrow funds, earn yield and interest on fund,s and even trade or leverage derivatives and cryptocurrency. For now, the major DeFI applications are centered around P2P Lending or Borrowing Platforms, Tokenization or NFTs, and enabling Decentralized Exchanges like PancakeSwap or SushiSwap.
The major cause for DeFI is it solves the problem around CeFI giving the control of a cryptocurrency or digital assets back to its users instead of being the intermediaries. People are custodians of their holdings which lead to greater inclusion or accessibility to financial services which would have not been possible through banks or CeFI. Furthermore, DeFI also provides transparency of information to its users which would have been deterred due to the regulations CeFI has to follow.
Obviously this all sounds good to all users who want a break away from the traditional Centralized system but why CeFI then is still heavily favored? Should DeFI be our future solution?
Should DEFI be the way to go?
The world is obviously constantly evolving, from early 2000 when internet was the next big thing to right now where blockchain and metaverse are the way to go. We live in a world where everything is centralized including finance and bitcoin really opens our view to new possibilities. A possibility of our financial system not being run by people who will tend to benefit themselves but by codes that are unbiased.
It obviously has to be pointed out that DeFi in its current shape is not the perfect solution for it and there is some benefit in CeFI that cannot or not yet been replicated by DeFI. Of course Smart Contracts or Codes cannot be changed but as we learned from the Flash Crash that hits the stock market in 2010, they can be hacked or tampered with. This is especially true with DEX like PancakeSwap which used an Automated Market Maker system to manage its liquidity which is easily manipulated by influencing the supply in each LP.
We know for sure that Decentralization and Blockchain are the way to go for the future and both CeFI and DeFI clearly have their own advantages for their specific users. The solution will rely on extracting the benefits of both these solutions into some form of a HYBRID, which reflects the Transparency, Privacy, and Security provided by DeFI with the Ease, Accessibility, and Regulations provided by CeFI and the local authorities. Till then CeFI will still remain the most used platform while DeFI and Decentralization should still be the future we are all heading into.
We in Nagaya Technologies Pte. Ltd are really pleased with the development going on in the crypto space with both CeFI and DeFI providing value to a lot of users out there. We obviously believe that both systems were meant to Co — Exist which leads to creating the world’s first hybrid cryptocurrency that combines physical projects and gold backup with the technologies of blockchain and cryptocurrency. To know more about our coin Nagaya, you can read our whitepaper at nagaya.io.
Or talk to us at t.me/nagayaofficial