- Although DeFi is currently unregulated, financial authorities are actively preparing to regulate it.
- CeFi refers to centralized exchanges and custody services, while DeFi protocols can be built in different ways.
Centralized Finance, commonly known as CeFi, is a popular approach to manage cryptocurrency trading through a central exchange. This method is similar to how traditional stock brokerages and investment companies manage trades in fiat cash and equity in the public stock market. Although CeFi is not as strictly regulated globally as fiat currency trading, it is subject to increasing rules in Western economies such as the U.S. and Europe.
Can CeFi and DeFi Co-exist?
CeFi typically requires users to comply with Know Your Customer (KYC) regulations, which aim to prevent tax evasion, money laundering, and terrorist funding by verifying their identity. In this model, a central exchange has custody of the assets and holds the private keys for cryptocurrency wallets that provide access to tokens on a blockchain, ensuring the safe and secure execution of transactions and accurate transmission of information to users.
Decentralized Finance, commonly known as DeFi, on the other hand, aims to eliminate centralized authority and uses decentralized exchanges (DEXs) to facilitate transactions. DEXs are not meant to function as transaction authorities but can aid in facilitating transaction flow. Decentralized apps (dApps), closely related to DeFi, can also support DeFi use cases by using smart contracts.
DeFi eliminates model fees frequently attached to financial services transactions as it is a decentralized model lacking a central authority to levy service costs.
Deep Dive In Recent History
In recent history, money and financial operations have been centralized, with banks, regulatory bodies, and governments having control over the supply of funds and conducting transactions. However, the emergence of cryptocurrencies is challenging and reevaluating traditional financial practices and operations.
Despite their differences, both CeFi and DeFi rely on blockchain technology as their core building component and provide a range of financial services related to cryptocurrencies, including buying, selling, and trading. Regulators worldwide are examining the introduction of these new financial concepts and working to establish a regulatory framework that balances the benefits of technical innovation with compliance to regulations and provision of consumer protections.
Security Concerns & Crypto Ecosystem
Both CeFi and DeFi carry a significant amount of security risk, with attackers targeting both models. CeFi, however, allows for extra security measures that the central government can and should take, although it may be simpler for regulators to impose other kinds of financial compliance on CeFi. It is worth noting that tax authorities may not go unnoticed by CeFi companies’ profits.
The coexistence of DeFi and CeFi is crucial for the advancement of the crypto ecosystem. However, recent incidents such as the collapse of FTX and the bankruptcy of CeFi entities like Celsius Network, BlockFi, and Voyager Digital have harmed customer trust, particularly as these platforms were favored for their user-friendly interface. As a result, DeFi platforms are gaining popularity among crypto enthusiasts due to their transparency and security.
Nonetheless, DeFi platforms are still a small percentage of the centralized exchange market cap and daily trading volume. DeFi lacks vital infrastructure and features like fiat conversions, margin trading, and limit orders, which CeFi platforms provide and are critical for DeFi’s broader adoption. DeFi relies on technology, providing users with a higher degree of accessibility, trustlessness, and quick innovation.