Introduction to Centralized Finance (CeFi)

  • Bhumika Dutta
  • Oct 05, 2021
  • Financial Analytics
Introduction to Centralized Finance (CeFi) title banner

With the advancement of blockchain and the emergence of cryptocurrencies in the field of technology, the financial world has found a new way of trading. Cryptocurrencies were created with the goal of decentralizing the financial trading system, but they were only used for cryptocurrency trading. 

 

So, centralized and decentralized finance (DeFi) was introduced which included other aspects like providing crypto loans, trading crypto derivatives such as Bitcoin Futures, and tokenizing digital assets along with crypto trading. 

 

Users' crypto transactions and activities are managed by centralized finance (CeFi) exchanges, which operate as a middleman. In this article, we are going to talk about Centralized finance, focusing on the following topics. 

 

  • What is Centralized Finance (CeFi)?

  • Difference between CeFi and DeFi.

  • Advantages of CeFi.

  • Disadvantages of CeFi.


 

What is Centralized Finance (CeFi)?

 

Before the concept of decentralization came into existence, CeFi was one of the revolutionizing technologies that combined some of the yield advantages of DeFi with the convenience and security of standard financial services products. To understand centralized finance, we need to understand what centralization is.

 

The process of centralization refers to the concentration of planning and decision-making processes inside an organization to a single leader or location. In a centralized organization, the head office retains decision-making authority, while all subordinate offices receive orders from the main office. The head office houses the executives and specialists who make crucial decisions.

 

All crypto trading orders are routed through a central exchange in centralized finance (CeFi). The money is managed by the individuals in charge of this exchange. This implies that one doesn't have access to their wallet since they don't have a private key. Furthermore, the exchange selects which currencies are available for trading and how much users must pay in fees to trade on their platform.

 

(Recommended read: What is the Future of Cryptocurrency?)

 

How can we generate revenue using CeFi?

 

According to Coinbase, CeFi offers the possibility of generating income through crypto-based accounts that are practically comparable to regular bank savings accounts but may provide significantly greater profits. 

 

Crypto deposits, unlike traditional savings accounts, are not yet covered by the government's FDIC or SIPC insurance, so one should be aware of the dangers. The main idea is to keep part of the cryptocurrency on one of the various sites that provide this service. 

 

Customers in several states in the United States may now sign up for a waitlist on Coinbase to begin receiving a 4% yearly return for owning USD Coins. These cryptocurrency assets are put to work and loaned out to others. The borrowers pay a centralized provider an interest rate for borrowing, and the centralized supplier transfers some of that interest to customers.

 

Applications of CeFi:

 

Some real-world applications of CeFi include: 

 

  • Fairlay: A Bitcoin Prediction Market and Exchange based on the CeFi concept.

  • BlockFi is a bitcoin and fiat lending and borrowing platform.

  • Celsius: A platform for bitcoin borrowing, payments, and lending.

  • Ledn: A platform for borrowing and lending Bitcoin to DAI.

  • Libra: A worldwide financial infrastructure platform with a cryptocurrency overlay.

 

(Related blog: What is Futures Trading? How to Trade Futures)


 

Difference between CeFi and DeFi

 

The following are the main differences between centralized finance and decentralized finance:

 

  1. The method of exchange of the two finances is the main difference. The system is regulated through exchanges in centralized finance. Decentralized finance, on the other hand, is technology-dependent. Binance, Coinbase, Libra, and some popular CeFi exchanges have been providing crypto-financial services for a long time. DeFi exchange is hosted on a blockchain platform like Ethereum. 

  2. Users shift their risk to the exchanges as a result of the exchanges' engagement in CeFi. As a result, exchanges are responsible for safeguarding users' money. These middlemen are removed in DeFi. The transactions are made on the assumption that smart contract protocols would be successful.

  3. Currency to crypto transfers and cross-chain solutions are made easier with centralized financing. If necessary, centralized finance can shift funds to assist clients or halt trade in the event of a negative occurrence, such as a hack.  DeFi, on the other hand, is seen as more transparent and non-intrusive because it does not require the customer's personal information and is non-custodial. CeFi, on the other hand, may prevent trade and impose limitations on users, but DeFi cannot.

 

(Must check: Commodity Trading: An Overview)

 

 

Advantages & Disadvantages of CeFi:

 

Even though DeFi is more popular than CeFi in many aspects, the following are some of the advantages of CeFi over DeFi:

 

  1. Centralized exchanges (CEX):

 

Users transmit funds to a typical cryptocurrency exchange, such as Binance, Kraken, or Coinbase, to manage them within an internal account. Though money is held on the exchange, they are maintained outside of users' control and are subject to threats if the exchange's security procedures fail.

 

As a result, centralized exchanges have been the subject of a variety of security threats. Customers on the centralized exchange do not mind disclosing personal information or entrusting cash to these firms because they believe central exchanges are trustworthy.

 

Furthermore, major exchanges have whole departments with customer care staff available to assist consumers. The high degree of customer assistance offers reassurance to the consumer, reinforcing the belief that their monies are in good hands.

 

(Must check: World’s largest stock exchanges)

 

 

  1. Fiat Conversion's Flexibility:

 

When converting cash to bitcoin and vice versa, centralized services offer greater flexibility than decentralized services. Converting bitcoin to money generally necessitates the use of a centralized organization; however, DeFi services do not provide cash in such a flexible manner.

 

Onboarding clients into the Centralized Finance (CeFi) ecosystem is simple and can improve the customer experience.

 

 

  1. Cross Chain Services:

 

CeFi services allow you to trade LTC, XRP, BTC, and other coins produced by independent blockchain platforms. DeFi services do not support these coins due to the latency and complexity of executing cross-chain exchanges. CeFi can circumvent this problem by obtaining custody of assets from different chains. It is a big advantage for CeFi because many of the most often traded and highest-market-cap currencies are on separate blockchains that do not implement interoperability standards.

 

 

Risks related to CeFi

 

  1. Higher Transaction Fees:

 

As there are a number of intermediaries present in a Ce-fi, the transaction fees automatically increase. This is one of the major reasons because of which people all around the world are moving towards a decentralized network.

 

 

  1. Malicious attacks of Hackers:

 

The primary disadvantage is that centralized systems are always attractive to hackers. The latter aims to take advantage of the platforms' high liquidity. As a result, they employ illegal computer techniques to hack the data, allowing themselves to take cash from clients. 

 

Customers in CeFi cede custody of their possessions to the exchanges. They also divulge personal information in these interactions. There is a genuine risk of losing cash if the exchange is hacked or subjected to a cyber assault. Even if the money is secure, there is a danger that your privacy will be jeopardized.

 

 

  1. Less transparency:

 

Because of the nature of CeFi systems, there is a lack of transparency. Platforms in the DeFi area are regulated by technology, especially smart contracts, which provide transparency.

 

(Suggested blog: Most Stable Cryptocurrency in 2022)


 

Conclusion

 

CeFi guarantees fund security and fair trade on such funds. Traditional currency investors can also participate in crypto trading. Furthermore, CeFi exchanges offer customer support services that DeFi services do not. CeFi acts by establishing trust along the route. It guarantees fund security and fair trade on such money.

 

Both of these models have advantages and disadvantages. It is dependent on the investor and their requirements. So, after reading this blog, by now you would definitely have a good idea of which one suits you the best.

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