Home Reviews CeFi (Centralized Finance) What Are They and How do They Work?

CeFi (Centralized Finance) What Are They and How do They Work?

Centralized finance refers to any kind of financial services (especially in the crypto industry) that a centralized platform manages and processes the transactions as well as accounts.

Centralized finance for CeFi is somehow the opposite of DeFi, where there is no centralized platform and people somehow interact with each other in P2P decentralized platforms for financial services.

These two systems found meaning when DeFi platforms came to action and showed the capabilities of decentralized financial services. CeFi was in action for many years in the form of cryptocurrency exchanges and other platforms. But it found a name and meaning exactly when the DeFi concept was born with decentralized exchanges like Uniswap and others.

We can consider any traditional financial platform as CeFi. Banks are a form of centralized finance platform that is in action for many years.

But the name of CeFi often refers to cryptocurrency financial platforms like crypto exchanges and so on. Trust, regulatory challenges, and sanctions are some of the limitations that CeFi has. It was the reason many people migrated to decentralized platforms. But still, most of the financial transactions in the crypto industry are managed through CeFi.

What is CeFi (Centralized Finance)?

Before DeFi came to action, CeFi was the only solution for trading cryptocurrencies. Although it competes with DeFi to attract mainstream crypto traders, CeFi owns the bigger share of the trading market in the crypto industry.

In CeFi platforms, all transactions and trading records are managed and processed in a centralized platform. The platform often is an exchange with an order book that acts as an intermediary for buying and selling cryptocurrencies.

Founders, owners, execs, and managers of a CeFi platform are responsible for managing the assets and keeping users’ holdings safe. In simple terms, the centralized financial platform is where your assets are kept. All of the orders will be channeled through a central exchange.

There are pros and cons in centralized finance platforms that result in attracting or losing traders. Some people love to trust a centralized platform with known managers and users, while others like the freedom of DeFi and migrate their trading activities to decentralized platforms.

CeFi types

Types of CeFi

As mentioned above, centralized finance refers to any financial service that relies on a centralized platform. Although many people know this concept with centralized exchanges, there are many types and models of CeFi in the market.

CEX (Centralized Exchanges)

Centralized exchanges are the most well-known types of CeFi. Traditional cryptocurrency exchanges like Binance, Huobi, and others are examples of this kind of crypto exchange.

These centralized exchanges are managed by a company that somehow needs to be regulated based on the place of activity. So, their rules and guidelines may change over time because of the decisions by the managing company or the regulating region.

In a CEX, there is an order book that is a collection of buy and sell orders that traders post on the exchange. Order means a request to buy or sell a cryptocurrency at a specific price.

The CEX keeps these orders and processes them using centralized software that matches the buy and sells orders. In a centralized exchange, you don’t own your funds, but the exchange keeps the custody and private key of them.

In simple terms, when you exchange assets in a CEX, no actual exchange happens. The platform just changes the number of holdings in your account. The actual exchange only happens when you withdraw the funds from your account.

There are many disadvantages to CEX, but still, most of the traders prefer them for trading. Ease of use, cost-efficiency, and trusting a single point of authority are the reasons people still prefer centralized exchanges. But these exchanges don’t reveal their internal operations and always have to obey the regulations of the region of operation.

Besides, centralized exchanges hold the custody of assets you deposit in them. Hackers always love to breach into these exchanges and find access to that custody.

Lending and Borrowing

Lending and borrowing are fundamental services in the finance sector. Traditional banks always provide these services in the form of loans and interest. Centralized finance platforms in the cryptocurrency industry are no exception. Most of the centralized exchanges have the option of lending or borrowing assets.

People needing extra money for their trading activities hold some of their assets as custody in a CEX and borrow assets in terms of loans. Those who want another way of earning crypto use these services by lending their holdings. They receive interest from the centralized exchange.

Buy / Sell Cryptocurrencies

Buying or selling cryptocurrencies with fiat money is the first need of everyone that enters the industry. Centralized exchanges had many problems in the first years of the crypto revolution to become able to sell cryptocurrencies to ordinary people. Governments had many strict rules for buying and selling cryptocurrencies.

But nowadays, we see most of the exchanges offer the chance to people to even connect their traditional bank accounts. Many exchanges around the world let you buy and sell cryptocurrencies for fiat money. Adding this option needs some regulatory processes that often lead to KYC rules.

KYC at CeFi

KYC is a regulatory requirement that almost all of CeFi platforms should deploy. Know Your Customer or KYC means financial platforms should receive identity documents from their users to prevent fraud and money laundering activities.

Most of the CeFi platforms receive this information from their traders, but they let their users trade in a limited amount of crypto without the need for KYC.

KYC is often needed when you want to buy and sell cryptocurrencies with fiat money. It helps a regulatory organization know people who convert their holdings to crypto. Later they can refer to CeFi documents to receive tax from the users or even arrest them for fraud activities.

CeFi Vs DeFi

CeFi vs DeFi

As mentioned above, the CeFi concept found a meaning when decentralized finance or DeFi came to action. These two concepts have similarities and differences with specific pros and cons. Each one has been successful in attracting traders, but still, CeFi owns the larger portion of the market.

Differences

The main different part between CeFi and DeFi is decentralization. DeFi doesn’t rely on a centralized organization for managing and processing the trades. People are connected to each other for trading cryptocurrencies. Besides, the decisions for the changes in a DeFi platform are made by groups of people. There is no company behind a DeFi, and governance token holders vote for or against any changes in the platform.

In DeFi platforms, traders own the custody of their holdings. When you exchange an asset in a DEX (decentralized exchange), the actual exchange happens, and you receive new tokens in the wallet. You have ownership of the wallet’s private key. Besides, there is no regulatory or sanction limitation in DeFi platforms. There is no need for KYC, and everyone can trade on DEX services.

Similarities

Bot centralized and decentralized finance platforms are here to serve people trade and benefit from financial use-cases f the crypto industry. They offer similar services like spot trading, derivatives trading, margin trading, borrowing and lending, payments, and the creation of stablecoins. Besides, some of the companies behind CEX platforms have participated in developing DeFi platforms.

Conclusion

Centralized finance has been in the crypto industry for a long time. It offers seamless services that are still attractive for traders. Although there are some disadvantages and some experts suggest not using CeFi, they’re more trustful and reliable for traders.

Besides, still, most of the traders are active in CEX platforms. As a result, there is a bigger market there, and you can exchange assets at better prices. DeFi still has a long way ahead for defeating CeFi. It’s still a bit hard to work in DeFi platforms, and the lack of liquidity still remains a problem in most of those platforms. Rug pulls and other challenges in DeFi platforms also resulted in a lack of trust for some mainstream users.

After all, CeFi and DeFi are both trying to attract more mainstream users to the crypto world. The competition between them surely comes with expansion for the whole crypto market.

Mehdi Zare
I am a young father who always loves to learn. Security and privacy topics are my main interests, and so, blockchain as one of the most strong security and privacy solutions of the modern industry excites me too.
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