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What is decentralized finance (DeFi)?
DeFi stands for Decentralized Finance, a blockchain-based form of finance that does not rely on central financial intermediaries to provide services. Instead, it uses smart contracts on blockchains. A smart contract is an automated code that runs on a blockchain and cannot be changed. Transactions that take place in a smart contract are processed by the blockchain without any third party intermediary.
There are several DeFi applications. DeFi platforms allow people to lend or borrow funds, speculate on price movements using derivatives, trade cryptocurrencies, earn interest on funds, and more. At the moment, DeFi applications mainly revolve around the following features: providing peer-to-peer or pooled lending and borrowing platforms and enabling DEXs (decentralized exchanges), tokenization, and prediction markets.
What is Centralized Finance (CeFi)?
Centralized entities run CeFi services such as centralized crypto exchanges. Most CeFi service providers tend to abide by the rules set by the local authorities they work for. These rules oblige centralized financial institutions such as exchanges and trading platforms to implement Know Your Customer (KYC) and Anti-Money Laundering (AML) practices.
In CeFi, centralized companies and institutions store your funds in their custodial wallets. These crypto wallets store the private keys of the users. In turn, these services provide various services to customers. Cryptocurrency trading is currently one of the most common solutions supported by centralized finance. In addition to trading, companies covered by CeFi provide services to their clients such as loans, lending, margin trading, etc.
DeFi versus traditional financial services
DeFi offers several advantages over traditional financial services. Using smart contracts and distributed systems, deploying a financial application or product becomes less complex and more secure. Overall, the DeFi movement is moving traditional financial products to an open and decentralized world, promoting financial freedom worldwide and eliminating the need for intermediaries, reducing overall costs and greatly improving security.
CeFi vs. DeFi
In terms of the financial services they offer, there are many similarities between CeFi and DeFi.
There are also significant differences between CeFi and DeFi.
In a centralized financial environment, exchanges or trading platforms are owned by a single individual or often a corporation. They provide various services to make cryptocurrencies more accessible to their customers. However, centralized exchanges are responsible for everything from user registration to setting ground rules and more. DeFi applications, on the other hand, aim to decentralize ownership and community ownership. Everyone has a say in how the application should function, as long as its code
run and maintained by the community.
In centralized finance, users must register and comply with KYC (Know Your Customer) rules. This is often done to prevent criminal activity such as money laundering and to comply with cryptocurrency regulations. In DeFi, if you have a non-custodial crypto wallet like MetaMask, you don’t need to go through the KYC process or sign up for an account.
In centralized finance, you have no choice but to trust your assets to exchanges and other centralized applications. In DeFi, you never need to trust anyone with your assets or if you want to trade them using a peer-to-peer swap or whatever.
Learn more about the differences between centralized and decentralized exchanges.
Recall that while both CeFi and DeFi offer similar concepts, the approaches are very different. The medium-term future is bright for both DeFi and CeFi as the financial crisis will highlight the importance of safe-haven assets with low correlation with traditional markets. It will also highlight the importance of blockchain solutions for all kinds of financial services that governments should not manipulate.
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