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If you’ve been in the crypto world for a while or you’re a newbie, you’ve probably come across the term “DeFi”. In today’s blog post we’ll be answering the questions; What Is Decentralized Finance (DeFi) And How’s It Different From Centralized Finance (CeFi)?
What is Decentralized Finance and how does it work?
According to Investopedia, Decentralized finance (DeFi) is an emerging financial technology based on secure distributed ledgers similar to those used by cryptocurrencies. The system removes the control banks and institutions have on money, financial products, and financial services.
Due to blockchains’ introduction and decentralized, permissionless features, new imputed currencies have evolved. The transfer and trade of financial assets without trusted intermediaries is one of the blockchain’s most powerful features. Furthermore, decentralized finance, a new sub-field of blockchain, focuses on developing financial technology and services on top of ledgers with smart contracts.
Decentralized finance uses the blockchain technology that cryptocurrencies use. A blockchain is a distributed and secured database or ledger. Applications called DApps are used to handle transactions and run the blockchain.
In the blockchain, transactions are recorded in blocks and then verified by other users. If these verifiers agree on a transaction, the block is closed and encrypted; another block is created that has information about the previous block within it.
The blocks are “chained” together through the information in each proceeding block, giving it the name blockchain. Information in previous blocks cannot be changed without affecting the following blocks, so there is no way to alter a blockchain. This concept, along with other security protocols, provides the secure nature of a blockchain.
What is Centralized Finance and how does it work?
In centralized finance (CeFi), all crypto trade orders are handled through a central exchange. Funds are managed by specifically running the central exchange. It means you don’t own a private key that provides you access to your wallet.
The primary principle behind centralized exchanges (CEXs) in crypto is that all crypto trading orders are routed through a central exchange under centralized finance. Examples of CeFi companies include Binance, Coinbase and Kraken. Users create accounts with these exchanges and utilize the same platform primarily to send and receive tokens. This isn’t all, though. These exchanges offer a variety of services in addition to crypto trading, such as lending, borrowing and margin trading.
You don’t own your cryptocurrencies when buying /selling via a centralized exchange. Moreover, you are subject to the rules a centralized exchange imposes on you. Also, you are subject to the rules set by the centralized exchange
One of the many advantages of Centralized Finance (CeFi) over Decentralized Finance (DeFi) is that they support cross-chain exchange for multiple cryptocurrencies, although these cryptos are generated on individual blockchains, thus displaying interoperability of cryptocurrencies. CeFi exchanges also enable the conversion of fiat currency to cryptocurrency and vice-versa easily and seamlessly.
READ ALSO: YOUR ULTIMATE GUIDE TO THE BEST BITCOIN WALLET APP IN NIGERIA 2022
Differences between Decentralized Finance and Centralized Finance
Below is a table highlighting the differences between DeFi and CeFi, using factors such as;
- Funds custody
- Services available
- Personal information
- Security
- Market cap
- Customer service
- Risk factor
| FACTORS | DeFi | CeFi |
| Funds custody | The user has complete authority over funds custody. | Outside of the user’s custody |
| Services available | Borrowing, Lending, Payments, Trading | Trading, Borrowing, Fiat-to-crypto, Payments and Lending |
| Personal information | Proof of Work | Pluggable Framework |
| Security | Not accountable for funds. | Vulnerable in case of security bridges on the exchange. |
| Market cap | $16 billion* | $324 billion* |
| Customer Service | NA | Provided by major changes. |
| Risk Factor | Security relies on the technology you are using. | Centralized exchanges are responsible for security. |
Source: LeewayHertz
Conclusion
Both Decentralized and Centralized Finance plan to make crypto trading popular and improve the trading volume. However, the way these two ecosystems carry out their objectives is different
Both of these models have their pros and cons. It depends on your needs. If you prefer transparency and privacy, DeFi is the right model to choose from. On the other hand, if your priority is trust, sharing of risks, flexibility and increased options to invest, you should opt for CeFi.
