In order to understand CeFi, let’s first talk about DeFi. DeFi is one of the most popular words in the crypto space, and the concepts of NFTFi, GameFi, and SocialFi are all its derivatives. Most people who inquire about DeFi-related information on the Internet may see CeFi, another word similar to DeFi.
Actually, CeFi is not a new concept but one that already existed in the traditional financial system for a long time.
CeFi, short for Centralized Finance, is the opposite of DeFi, Decentralized Finance. Actually, the concept of CeFi already existed in the traditional financial system for a long time, but it is only in recent days that it is created as CeFi to define all existing mainstream financial systems, such as banks, stock exchanges, and various financial institutions.
Specifically, the concept can be traced back thousands of years ago when the bankers in Florence, Italy in the 15th century began to use this concept. So, it has been applied for hundreds of years.
After DeFi was born, the concept of CeFi was created to represent the existing centralized financial systems and to distinguish itself from the term of DeFi.
DeFi is an encrypted financial system derived from the blockchain. Applications in different directions such as decentralized exchanges, decentralized lending, and liquidity pools are typical representatives of the concept of DeFi. However, CeFi is used in much broader areas in the crypto space. It is designed to create more encrypted investment opportunities, offer more advantages to help gain profits, and make some traditional financial products safer and easier to use.
Since DeFi today is characterized by transparency, some crypto users will think that the existence of CeFi no longer makes sense. In particular, they believe that there is no need to introduce CeFi’s financial system principles to the crypto industry.
However, this doesn’t mean that CeFi cannot play a role in the rising crypto industry. Instead, its unique value has been properly integrated into cryptocurrencies which have further promoted its liquidity and exchange by virtue of traditional fiat currencies.
Many of the current popular perceptions of DeFi are actually produced in order to differentiate the traditional centralized financial system, which also inspires people with the idea of applying this basic concept to the crypto space.
Most centralized exchanges are currently built and growing based on Web2 elements. Neither the R&D for financial products nor the marketing of growth strategies has anything to do with the basic principles of Web3. However, if the crypto space wants to grow further, it is crucial for the entire industry to provide an easy entrance for groups other than crypto users to obtain the corresponding crypto assets.
Whereas, it is obvious that DeFi provides a threshold that is too high for many ordinary people, making it difficult for beginners to understand various contracts and circulation rules of cryptocurrencies among different institutions.
Moreover, if trading between cryptocurrencies and fiat currencies is done in full accordance with the principles of DeFi, there will inevitably be some contradictions between the centralized and decentralized financial systems, resulting in multiple unnecessary problems.
It is against this backdrop that people need to apply the centralized financial system in the crypto space to serve themselves, be it the transition from Web2 to Web3, or more users who need a set of established and mature financial rules to participate in, especially to exchange fiat currency for crypto assets.
Meanwhile, different financial regulatory agencies are currently unable to accept the complete adoption of DeFi as the major financial circulation model. Because of these factors, the centralized financial system is put into use in the crypto industry in a more natural way and the concept of CeFi which is opposite to Defi has also been officially confirmed.
Theoretically, decentralization via smart contracts can make the financial system a more fair and more transparent place. It can also solve many unavoidable problems in the traditional financial system. Besides, the cost of this system will be much lower because a dedicated centralized operating team is unnecessary.
DeFi has become one of the popular sectors in the cryptocurrency field, but we need to wait and see how this financial system based entirely on code contracts will develop in the market. It is necessary for this sector to explore its regulatory regulations, product maturity, market demand, and other demands in its advancement.
There is no need to introduce too much about CeFi which refers to the area including the existing traditional financial systems, banks, financial institutions, exchanges, and even cryptocurrency exchanges including Huobi, OKEx, etc. All these institutions are running under centralized financial trading rules.
Lots of content promoting DeFi and decentralization often highlight the shortcomings of CeFi such as opacity, ease of manipulation, and low security. It is believed that DeFi will replace CeFi. As a matter of fact, those are exaggerated remarks, because DeFi and CeFi are not mutually exclusive. They do not compete with each other and one will not necessarily replace the other, but each has its own characteristics, and the two complement each other.
CeFi and DeFi have three major differences.
When using the services of the exchange, users need to recharge funds into the account of the exchange and manage them in the internal account. They utilize the funds under the mechanism of the exchange center. Although the user’s funds are stored in the exchange, the funds are at risk to some extent because it is not the users themselves who keep the funds and there may also be some hidden dangers in security measures adopted by the exchange.
CeFi usually supports the trading of BTC, LTC, and XRP as well as the issuance of other major tokens on independent blockchains. Since cross-chain services are often complex and delayed, DeFi usually does not support cross-chain services. However, CeFi overcomes this problem by taking funds from multiple chains, which is a big advantage of CeFi. It is for this reason that many of the BTCs with relatively high market capitalization and the most frequent transactions are on independent chains.
Compared with DeFi, CeFi offers more flexible services, especially in the conversion of fiat currency to cryptocurrency. So far, the conversion between legal currency and cryptocurrency relies on a centralized service entity and most DeFi services do not provide legal currency conversion channels. Therefore, it is more convenient for new users using CeFi services to enter the crypto industry and they can also enjoy a better user experience.
We did not use CeFi until the term DeFi was born because when Defi did not emerge, the financial system of the entire world operated in a centralized manner whether it was the government, banks, or stock markets. The asset sovereignty, point-to-point transactions, and access-free methods brought by DeFi are enough to inspire us to explore more possibilities of on-chain finance, and let us fully realize how absurd and unreliable the so-called CeFi is.
From a traditional perspective, CeFi is indeed convenient and secure. Taking exchanges as an example, most CeFi exchanges also have sufficient fiat currency deposits and withdrawals. It can be proved from multiple perspectives that CeFi has advantages that DeFi cannot make up for at least temporarily.
Regarding ease of use, the services that CeFi can provide are very convenient. After all, the experience of using the current crypto wallet still needs to be improved. It is unfriendly to novices. But when it comes to security, we believe that after a series of incidents such as LUNA, 3AC, and the recent FTX, everyone has a measure in their mind. Security is only relative, and the dangers brought by centralized operations are sometimes devastating.
There have been multiple incidents related to CeFi since 2022, especially the liquidation caused by 3AC and the bankruptcy of the FTX exchange which misappropriated customer assets. These incidents are undoubtedly a serious blow to the industry, and it also destroys the users’ confidence. It can even be said that these CeFi leaders have not only taken advantage of their users but even the entire industry.
Another topic that can be derived from this is the many problems faced by CeFi in its application in the cryptocurrency industry. The first is a compliant regulatory system. If the entire encryption industry wants to develop further, it needs more funds from major holders. It is very necessary to provide these funds with sound market rules and protection mechanisms.
It is especially necessary to build up users’ confidence at a time when they are increasingly losing confidence in centralized institutions after witnessing hacking incidents, institutional liquidations, and exchange bankruptcy.
After witnessing the recent FTX incident, the public has lost confidence in exchanges, and some exchanges have even experienced runs. However, the Gate.io exchange still has abundant asset reserves and recently announced a 100% asset reserve statement. Gate.io can be trusted, as always.
On the other hand, the time has shown that the DeFi field lacks a comprehensive and effective security audit mechanism, resulting in losses caused by countless hacker attacks. In terms of code errors, BUG utilization, and token design issues, hacking incidents in the DeFi field have caused hundreds of millions of dollars in losses to the industry.
To solve these problems, it has become a consensus to add an audit mechanism to DeFi services, equipped with standards and certifications to solve the problem of DeFi’s financial security. This method is learned from CeFi, and it can be properly adjusted to suit the specific situation of DeFi. The effect of CeFi on DeFi in terms of mechanism is playing a role in funds in this respect.
The next step after the DeFi audit is a financial audit, which will solve the potential loopholes from a market perspective. It is the cooperation between traditional finance and digital finance, and it is also a topic that CeFi practitioners are thinking about.
Of course, CeFi’s positive impact on DeFi in terms of security is not limited to those mentioned above. Many centralized financial principles have been applied in DeFi-derived movements. For example, the staked vaults in many GameFi products reflect the principles of CeFi.
The original vision of DeFi was to create a system without vertical authority, an ideal that consensus is reached by the community in a fair and transparent way. If it can be combined with CeFi to bring more security measures and products ease of use, then this will promote the encryption technology to be used widely, ultimately creating a fairer, more transparent, and safer financial environment.
Although the CeFi model has been running for a long time, various incidents such as liquidation, bankruptcy, and hacking have repeatedly occurred when it is applied in the emerging cryptocurrency market. Those are public lessons related to assets that all users can learn from.
We cannot deny the convenience brought by CeFi and its important position in the cryptocurrency market. However, when the market is not fully regulated, in addition to depositing funds through exchanges or purchasing financial contracts, it is recommended that all users purchase a cold wallet to preserve personal assets as well as play a role in diversifying risks, so as to avoid the occurrence of the worst cases.