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Thought leadership | 10/08/2020

DeFi vs CeFi: How DeFi Measures Up

DeFi vs CeFi

Key Takeaways:

  • Both DeFi and CeFi are poised to shake up the way people manage their money, but each has its own place in doing so. 
  • DeFi offers impressive transparency, accessibility, and utility for digital asset users, but it doesn’t yet match the overall functionality offered by CeFi—yet. 
  • CeFi is still by far the bigger industry, but DeFi is hot on its heels and growing at a breakneck pace. Support for fiat currencies remains one of the key ingredients DeFi is missing to appeal to a larger user base.

Whether you’re a fan of decentralized finance (DeFi) or centralized finance (CeFi), both have exploded in popularity in recent years, as digital assets like Bitcoin (BTC), Ethereum (ETH), and Tether (USDT) have enabled a new wave of both decentralized and centralized financial solutions that empower both fiat and digital asset users. 

DeFi refers to the decentralized protocols, platforms, and services that offer a parallel to traditional financial infrastructure like banks and state-run financial institutions, whereas CeFi is a middle ground of sorts, offering centralized platforms that bridge the legacy finance platforms with the new digital asset economy, by providing financial services to digital asset and often fiat currency users.  

Though both look poised to shake up the finance industry, they are different in many respects and will have different roles to play in the future of finance. 

Advantages of DeFi

Decentralized finance emerged out of an intense need to provide a complete range of financial services to digital asset users, without sacrificing the core tenets upon which these assets were built. 

Unlike many CeFi and traditional finance (TradFi) solutions, DeFi platforms and protocols are completely permissionless. This essentially means no centralized entity is at the helm deciding who can or cannot use the platform, ensuring DeFi platforms are open for absolutely anybody to use. 

Since these platforms can be used by anybody with a digital asset wallet, they represent more accessible alternatives to banks, lending firms, money markets, and other TradFi platforms, providing an open and accessible solution that could provide crucial services to the unbanked

Being based on publicly viewable blockchain platforms, DeFi services benefit from absolute transparency—allowing anybody to audit both the code that powers that solution’s smart contracts and the transactions that it processes. This means there is less uncertainty about what is going on behind the scenes, giving DeFi users peace of mind. 

The assets yielded or generated by DeFi platforms can be freely traded on external platforms, and users are generally free to do what they wish with these assets—unless they opt to lock or freeze these assets for a fixed period of time. 

Disadvantages of DeFi

As we previously touched on, DeFi is all about empowering users to manage their own money without relying on banks or other financial institutions. Though this can be liberating in many cases, it can represent a risk, since there are no chargeback features or protection mechanisms in place to prevent users from losing money. 

With DeFi, users bear full responsibility over what happens to their assets. Lost private keys and mistyped wallet addresses are two of the most common reasons users can irretrievably lose their assets. With CeFi, however, the centralized authority often has provisions in place to protect users from losses, such as a dispute arbitration or refund system, acting as a buffer of sorts for user error. 

Moreover, while many DeFi platforms offer genuine utility to users and can be profitable to use, there are swathes of platforms that offer no genuine utility or are outright scams. Unlike with CeFi platforms which are generally run by public-facing individuals and registered companies that can be held accountable, those affected by shady DeFi projects have little to no legal recourse. 

Some of these platforms also exist in an unusual regulatory position, since they may allow users to access services that would be prohibited or regulated in their jurisdiction—posing a challenge for regulators and users that want to keep things above board. 

The Current State of Play

As it stands, CeFi platforms drastically outnumber DeFi in terms of both the number of users and total market size. 

There are far more well-established CeFi platforms than DeFi ones, since CeFi platforms like centralized cryptocurrency exchanges and lending platforms have had several years to develop intuitive, accessible user experiences, and offer services that DeFi platforms still struggle to match—including direct support for fiat currencies like the US dollar (USD) and euro (EUR). 

CeFi platforms also offer a more familiar proposition to users, since they generally offer a custody solution as part of their offering, helping newcomers avoid some of the risks that can come with managing seed phrases and keeping private keys safe—like irreversible loss.

Nonetheless, the DeFi industry has grown at a staggering pace in recent years and new, ever more innovative and appealing DeFi platforms are appearing regularly, closing the gap between CeFi and DeFi capabilities each time. As such, it may not be long until choosing between CeFi and DeFi is a matter of preference, rather than usefulness.

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