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DeFiFinanceGuide

CeFi Vs. DeFi: Key Differences

Introduction

Financial services have been evolving and changing since the beginning of human civilization. At first, people only used the barter system and exchanged goods against other goods. Eventually, monarchs issued coins, and when democracy took over, the use of paper money became more prevalent under democratic governments.

However, the next step in financial evolution is blockchain, cryptocurrencies, Web3, and DeFi space. Every investor needs to learn the various aspects connected to DeFi and CeFi.

What is Centralized Finance?

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Centralized Finance envelops all financial functions and organizations that are performed under the purview of a regulatory body. It means that there is a third-party supervisor monitoring and verifying all financial transactions on the CeFi platform.

It is worth noting that all traditional financial functions are centralized, but all centralized financial functions are not included in traditional finance.

Centralized finance involves appointing a legal tender that holds an agreed-upon value. All stakeholders in a CeFi system agree to the value of the legal tender and use it as a medium of exchange.

How does CeFi Work?

CeFi is a financial system that is an immediate evolution of the barter system. In a barter system, one person producing a product such as wheat by farming gets to purchase shoes or clothes from a cobbler.

However, this system had many flaws since there was no way to measure the real value of a product or a service based on the amount of labour put into it.

Therefore, appointing a legal tender such as coins, beans, cowrie, etc, helped people to quantify the market value of a product or service in the shape of a new unit. In this manner, governments or monarchies gained more power over the masses by becoming the sole authority in deciding the exchange value of various merchandise.

CeFi and TradFi

Before the advent of DeFi, it was impossible to distinguish between TradFi or Traditional Finance and CeFi. However, with the introduction of cryptocurrency trading, many exchange markets started to appear, such as Mt. Gox. Meanwhile, the exchange markets for TradFi products such as securities and stocks already existed, such as NASDAQ and NYSE, etc.

The first ever cryptocurrency exchanges also faced a lot of issues on account of a lack of regulatory clarity or any legal groundwork available for them. Therefore, cryptocurrency exchanges like Coinbase decided to become centralized.

Now with the presence of Centralized cryptocurrency exchanges, the distinction between DeFi, TradFi, and CeFi has become very visible. The term CeFi now represents the exchange platforms that are offering cryptocurrency transactions and other financial products under regulatory supervision.

On the other hand, CeFi has detached itself from TradFi where only traditional investment activities such as stock trading, commodity exchanges, real estate business, derivatives, and Forex commerce take place.

At the same time, CeFi has also become distinct from DeFi where users do not have to abide by the government financial laws or comply with the user verification process.

Advantages of CeFi

Rapid Transactions

The transaction speed in TradFi is usually slower because it takes a lot of time in documentation and verification of the user. On the other hand, DeFi can also take a lot of time to confirm one transaction on account of PoW mining.

Meanwhile, CeFi networks are most efficient in terms of both user and transaction verification processes. It uses the TradFi method for user verification and PoS for transaction confirmations.

Increased Trading Volume

When cryptocurrency exchanges became centralized, many financial companies also jumped into the marketplace. Most financial companies refrained from adding cryptocurrencies to their trading portfolio on account of regulatory absence.

Therefore, as soon as CEX platforms increased in number, it also facilitated the increase of the trading volume. It meant that more investment capital was flowing in crypto, and at the same time, the opportunities for investing also grew consistently.

Cross-chain Support

Cross-chain support is a big innovation for investors who are using CeFi. Before the introduction of CeFi, the investors had to split their investment portfolios between two separate platforms for managing TradFi and DeFi products. However, CeFi platforms like Robinhood, eToro, Webull, and others allowed investors to perform both stocks and cryptocurrencies on the same platforms.

Furthermore, DeFi developers also created parachain protocols that joined one blockchain with other with CeFi.

Customer Services

One of the biggest setbacks for DeFi users is that in case of any mishap, the investors cannot contract anyone. The centralized authority is inherently missing; at the same time, there is also no technical support such as Customer Services.

Therefore, CeFi platforms were able to fill the gap in communication between the service providers and the users. On CeFi, users can seek help from the Customer Services department often available 24/7.

User Friendly

Both DeFi and TradFi require a considerable amount of technical knowledge to invest successfully. However, with CeFi platforms, users can choose different packages that grant them access to important tools such as technical analysis and consultants.

It means that the consumers can start small and build their portfolio by learning and gaining experience gradually.

Limitations of CeFi

Transaction Fee Inflation

Transaction fees in CeFi are often subject to massive inflation rates. The main reason for this free inflation is that the miners can take a lot of time for verification which prompts investors to offer higher gas fee rewards.

On the other hand, the blockchains where the consensus model is PoS, the investors can also face increased inflation fees on account of increasing trading volume on the network.

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Fund Flow Issues

Fund flows in CeFi are very unilateral. Once the funds are transferred to another digital wallet account, it is impossible to reverse the transaction.

Most CeFi platforms do not offer any escrow accounts for the user where the funds can incubate while the transaction is confirmed. Additionally, there is no presence of any legal authorities in CeFi which means that the transactions are irreversible.

Personal Information

Unlike DeFi platforms, the CeFi accounts require the input of the personal information of the users. It means that the users have to comply with the KYC and AML authentication process and provide their real legal name, address, and active email address.

It means that the verification process is slower in comparison to DeFi platforms, but hackers can’t create fake accounts and scam people.

Traceability

Traceability in a CeFi platform is very common. In most DeFi and TradFi platforms, government authorities can gain access to the account information and transaction history of the users.

However, in DeFi, users can adopt different techniques to mask their exchange tracks. Meanwhile, with CeFi all the user information is shared with government authorities.

What is DeFi?

DeFi or Decentralized Finance, is a type of financial ecosystem that is relatively new, and it started with blockchain. Without cryptocurrencies and DEXs, there is no existence of Decentralized Finance.

For the first time in history, DeFi has created a trustworthy and universal financial network where people can exchange transactions without a centralized regulator. It means that the people who are exchanging money on the network do not have to depend on the government or any financial regulator for verification of their financial transactions.

Most people cannot imagine sending anyone money from a platform that is not registered with a government or a private financial firm. However, DeFi has made it possible now.

How does DeFi Work?

Just like CeFi was an evolution of the barter system, DeFi is seen as an upgrade of the CeFi. With CeFi, the users were able to make transactions with a relatively smaller threat of getting scammed. However, with CeFi, all the information and personal details of the users are under the control of governments.

Therefore, anyone who is not working in line with the government-issued laws can be cut off from the financial network and face massive penalties. Even the most democratic governments have the potential to create fascist laws. However, with DeFi, people can send and receive money outside of the centralized money channel.

At the same time, DeFi also breaks the monopoly of government power over the financial system in a country. In many cases, countries with corrupt government leaders can create laws to favour the selected few to the detriment of the countrymen.

Therefore, DeFi has gained more popularity as a medium of exchange that can allow users to exist outside of the centralized government influence. Furthermore, DeFi is a borderless monetary network, whereas CeFi is limited to a specified country or region only.

Advantages of DeFi

Discretion

The secrecy of personal user information is a very important advantage of DeFi platforms. While anyone at any time can access all the transaction history data available on a DeFi network, there is no need for personal info.

The users on DeFi can create pseudonymous accounts. It means that anyone can create a new account under any ID or adopted moniker. At the same time, the users can also create as many accounts as they want.

Trusted Networks

DeFi platforms are trusted networks; it means that there is no need for the introduction of any government or private financial organization. In TradFi financial channels, the presence of a third-party verification party is very important. However, DeFi networks can verify the transactions on the network using miners, smart contracts, and other automated protocols.

Transparency

Transparency is one of the golden qualities of DeFi networks. It entails that anyone who is using the blockchain can access all the transactions present on it and check them. However, with DeFi it means that the users on the platform have to compromise their transaction details.

Since all the accounts are generated under assumed names, the transactions usually are untraceable to a real person. A DeFi platform also reserves the right to retain the information of the users from governments or other financial institutions.

Universal Trading

DeFi networks are universal trading platforms. With a legal tender, a person can only perform financial transactions within the country. However, with DeFi networks, anyone can join hailing from any part of the world using the internet and a suitable operating system.

Limitations of DeFi

Lack of Cross-Chains

There is a lack of cross-chain platforms on DeFi platforms. Since DeFi platforms can contain so many users who are working under assumed names. Therefore, most centralized financial networks do not integrate these channels. It can result in hackers entering from one platform to another, looking for exploits and illegal entry points.

Complicated

DeFi platforms are not ideal for beginners and new investors. In most cases, these platforms carry a considerable amount of risks; therefore risk mitigation skills of a seasoned investor are well-suited.

On the other hand, a DeFi network is typically teaming with hackers and programmers, and a person with little technical logic can get stuck with scams and hack attempts.

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Key Characteristics of CeFi and DeFi

Public Verification

Public Verification is necessary for CeFi users. The users have to comply with KYC and AML verification process with CeFi platforms. However, for DeFi users, it is not important to provide any personal information to create a new trading account.

Transaction Blocks

Transaction blocks are present on DeFi, which means that all the transactions available on one blockchain can either get verified as a whole or get rejected altogether. This quality is called atomicity, and it is a special protocol on the DeFi to increase its authentication quotient.

On the other hand, the CeFi platforms can perform individual transactions without getting any response from the users.

Secret Deployment

It is common for DeFi protocol to have a secret deployment and development party. Take, for example, the Bitcoin blockchain is the first network that was introduced by a secret individual called Satoshi Nakamoto. On the other hand, CeFi networks have legal and verified developers and managing corporations.

Custodial Services

Custodial services for DeFi are independent, and the users can enjoy full control of their account credentials. It also means that DeFi users have the full responsibility to keep their accounts secure against any legal, financial, and hacking threats.

On the other hand, the CeFi platforms usually reserve the private key of all the accounts present on the network. These platforms also assume the responsibility to keep all the user accounts secure and have ownership over the contents of user reserves.

Crypto Trading

CEX or CeFi platforms have off-chain order books in the same fashion as TradFi networks. On the contrary, DeFi uses Automated Market Makers that match the transactions requirement of one user with another automatically. Furthermore, cryptocurrency prices are also determined by these AMMs based on factors like liquidity, demand, supply, trading volume, etc.

Scalability

Execution orders on DeFi platforms are publically shared with peers or stakeholders available on the network. In this manner, any peer who can contribute to completing the transaction cycle can get notified and join.

However, the increased scalability of incomplete transactions on DeFi platforms has resulted in financial scams and manipulative trading practices.

In contrast, CeFi networks abide by rules provided by government authorities to create and implement an executive order which warrants its safety.

Gas Fees

Gas Fees on CeFi networks are typically lesser in comparison to DeFi. DeFi platforms need to implement transaction fees to ensure user viability and discourage spam transactions.

On the other hand, CeFi platforms have active cyber security monitors who prevent spam accounts and make sure that they have the option to offer no gas fee or implement very small percentages.

Business Hours

CeFi platforms often struggle with outage timing on account of massive traffic input. Meanwhile, DeFi can keep working around the clock with a little incident of exploits.

Privacy

Privacy of users is very high on DeFi platforms, while the discretion for transaction history is non-existent. Permissionless networks allow everyone to view and access transaction data on the platform.

On the other hand, the user information needs to be verified with legal pretext on CeFi, whereas the transaction information is reserved with only a few authorized personnel.

Arbitrage Trade

Arbitrage means buying products from a market at prices that are low and selling in another for higher. On CeFi platforms contain higher arbitrage risks.

Most CeFi platforms do not have atomicity protocols. On the contrary, DeFi platforms usually have atomicity protocols that will reserve the arbitrage transaction if it is not profitable for the user.

Devaluation

Devaluation of cryptocurrencies on CeFi is lower in comparison to DeFi networks. DeFi currencies are subject to higher price volatility in comparison to centralized tokens on account of intrinsic trading risks.

Fiat Conversion

CeFi platforms usually take a lot of time before listing new cryptocurrencies to their account. These platforms are operated by companies and individuals who are in the public eye, and they have to protect their product integrity.

On the other hand, DeFi protocols are anonymously deployed, and the users have full responsibility to safeguard their portfolios. Therefore, DEX can enlist more cryptocurrencies and offer higher conversion options.

Conclusion

Throughout the history of financial transactions, academics have come up with new methods to refine the process and make it more efficient. Barter, TradFi, DeFi, and CeFi represent the evolution of financial networks in chronological order. Both DeFi and CeFi offer considerable advantages, and both have room for further improvement. By learning about different types of financial systems, investors can strengthen their trading prowess.


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Hassan Mehmood (Saudi Arabia)

Hassan is currently working as a news reporter for Tokenhell. He is a professional content writer with 2 years of experience. He has a degree in journalism.

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