Traditional financial services such as payments, lending and borrowing were only available via established financial institutes and banks. But it transformed with the introduction of blockchain technology.
In previous articles, we did mention about Decentralized Finance (DeFi). In this article, we shall discuss all about Centralized Finance (CeFi).
WHAT IS CENTRALIZED FINANCE (CEFI)?
Before DeFi was introduced, Centralized Finance was the standard for trading cryptos. It handles a stronghold over the cryptocurrency industry. In centralized finance (CeFi), all crypto trade orders are handled through a central exchange. Funds are managed by specific running the central exchange. It means you don’t own a private key that provides you access to your wallet. Moreover, the exchange identifies which coins they list for trading or how much fees you need to pay to trade with their exchange.
In summary, with Centralized Finance (CeFi), 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.
ADVANTAGES OF CENTRALIZED FINANCE (CEFI)
#1. THE INVOLVEMENT OF EXCHANGES
In centralized finance, users transfer their crypto holdings to exchanges. These exchanges bear the risk of keeping the holdings secure and the responsibility of putting them to good use.
In this context, one needs to be mindful of the fact that these exchanges were not built in a day. They gained their reputation by successfully handling the funds of their customers for years. Since blockchain technology is a technology-intensive and rapidly developing field, many investors often find it challenging to properly trade. Exchanges share this responsibility.
The reputed exchanges employ 24/7 customer service teams that assist the customers and guide them through these challenges. Adoption is still complex due to the recent transformations in DeFi through yield farming. Many complex DeFi use cases have been created that are hard to explain to crypto beginners.
Therefore, these exchanges share the responsibility of educating their customers. This also allows them to slowly adopt more advanced use cases, such as yield farming, to offer it to their customer base. Just take a look at the great knowledge center Binance has created.
#2. MORE FLEXIBILITY IN CONVERSIONS
Converting fiat to crypto requires a centralized exchange. This makes client onboarding easier for the exchange and convenient for the client. Most of the new customers who come with fiat currencies can not convert them to crypto in DeFi. Similarly, taking withdrawals in fiat requires conversion from crypto. The presence of a centralized exchange is always beneficial in that regard.
#3. DIVERSITY OF TRADING OPTIONS
The decentralized finance system requires their tokens to follow Ethereum standards or the standards of the platform they are active on. For example, an Ethereum-based decentralized exchange (DEX) only supports trading ERC20-based tokens through its smart contracts.
On the other hand, centralized finance systems are free from such restrictions. CeFi supports a host of popular coins that are generally issued in independent blockchains. As trusted centralized exchanges, CeFi services can take custody of funds from these independent blockchains. Whereas DeFi services suffer from complexity and latency when performing swaps across multiple blockchains.
This diversity offered by the CeFi services goes a long way to differentiate the two. Most of the high-volume and high market-cap coins are traded on independent blockchains. These independent chains are still beyond the reach of decentralized finance.
WHAT ARE THE RISKS OF CEFI?
In CeFi, the customers transfer the custody of their holdings to the exchanges. They also provide their private details to these exchanges. In case the exchange is hacked or suffers from a cyber attack, there’s a real chance of losing funds. Even if the funds are safe, there is a risk of compromised privacy.
One needs to keep in mind that a transparent transfer of holdings and the associated risks are what makes centralized finance a trustworthy system. As far as the risk of hacks and attacks are concerned, almost all the exchanges deploy blockchain analysis companies or blockchain forensics. These companies monitor transactions, addresses, and the flow of funds continuously. They report any potentially fraudulent activity via alerts in real-time. This makes centralized finance reliable and mostly protects customers from the risks of cyber intrusions.
CONCLUSION
CeFi promises security of funds and fair trade on those funds. Investors with conventional currency can also take part in crypto trading. Moreover, CeFi exchanges provide them with customer support services that DeFi services do not offer.
CeFi, which same as DeFi, has its pros and cons. If users prefer transparency and privacy, DeFi is the right model to choose from. On the other hand, if their priority is trust, sharing of risks, flexibility and increased options to invest, you should opt for CeFi.
