CeFi and DeFi: Complementary and Moving Towards Integration

This article is from Forbes, originally titled "How The Ethereum, EOS, And Polkadot Communities Got Divided Into Two: CeFi Vs. DeFi," by Oluwaseun Adeyanju, compiled by Chain Catcher Echo.
From the perspective of crypto enthusiasts, the financial system is divided into two parts: traditional finance and cryptocurrency finance. The crypto space is further divided into centralized finance (CeFi) and decentralized finance (DeFi), which is the result of this split.
One of the original intentions of cryptocurrency was to establish a completely peer-to-peer network without intermediaries like financial institutions; however, the reality is different.
First, there are two ways for users to acquire cryptocurrency: by accepting cryptocurrency payments or by exchanging fiat currency, such as dollars. Most users enter the market through legitimate means, making the idea of circumventing financial institutions difficult. Most countries have anti-money laundering regulations that require financial service providers to prevent the illegal use of their platforms. Therefore, services that allow people to exchange fiat currency for cryptocurrency are subject to existing regulations, but governments in various countries (such as China and Japan) have a long history of cracking down on cryptocurrency trading.
Second, in a fully peer-to-peer crypto world, without any centralized institutions in between, each user is responsible for managing their own risks. This requires users to protect their private keys, as losing a private key could result in irretrievable digital assets. This experience differs from that of users in traditional financial institutions, where the assets deposited by users are somewhat protected. Thus, a familiar setup is necessary. These two issues together directed the early development of the crypto world towards CeFi.
As the cryptocurrency market gradually evolved into a multi-billion dollar market, a segment began to establish financial services relying on self-executing computer algorithms based on smart contracts, requiring greater flexibility and broader options. In some cases, decentralized communities composed of entities or participants determined how services operated, which is the foundation of decentralized finance.
1. What is CeFi
As the name suggests, CeFi consists of a financial system in which users entrust their funds to third-party entities. Users of CeFi services fundamentally trust that business managers will adhere to high ethical standards, a trust function that is borrowed from the traditional financial sector.
Dashdorj states, "CeFi is an extension of the existing financial model, but it has been upgraded to a new level through crypto technology. It alleviates one of the biggest pain points of traditional financial systems—accessibility—while retaining usability and simplicity, as it is more familiar to most people."
Dashdorj also mentions, "CeFi breaks down barriers to financial services, meeting the urgent needs of users who are dissatisfied with or unable to use traditional financial services."
Examples of CeFi services include centralized exchanges like Coinbase and Binance, as well as stablecoins like USDC from Coinbase and the Facebook-led Libra stablecoin. These stablecoins fall under the CeFi category because they are backed by a centrally managed dollar peg of 1:1.
Cryptocurrency storage and lending services like BlockFi, Celsius, and Pokket are also centralized financial institutions. Generally, CeFi refers to any service that helps users safeguard the private keys of their owned crypto assets through third-party platforms.
The only decentralized aspect of CeFi is that these services have established use cases for decentralized cryptocurrencies (such as Bitcoin, Ethereum, and Litecoin).
2. What is DeFi
Brian Kerr, CEO of DeFi platform Kava Labs, states that the core idea of DeFi is to bring complete decentralization into the crypto ecosystem.
"Unlike CeFi services, DeFi protocols and applications are open-source and run on the cloud by numerous operators worldwide. The software is open and accessible to anyone with internet access and does not require KYC or cumbersome login processes similar to those in the traditional financial world," Kerr states.
In other words, DeFi services are permissionless and trustless. Experts believe that the freedom provided by DeFi comes with the responsibility for users to manage their own risks. In contrast to CeFi, users of DeFi applications are primarily responsible for their private keys.
Moreover, DeFi services are not foolproof. A recent report from crypto intelligence firm Ciphertrace indicated that approximately $98 million in cryptocurrency was lost due to hacks targeting decentralized finance protocols between January and the end of October. The situation worsened in the first half of November, when DeFi service provider Akropolis lost over $2 million due to a hack.
Examples of DeFi services include decentralized exchanges like Uniswap and dYdX. With these services, users can connect their crypto wallets to exchanges for trading, without a centralized entity holding and managing users' assets. Autonomous lending services (such as Compound and bZx) also fall under the DeFi category.
There are also stablecoins in the decentralized crypto world, which are backed by decentralized crypto assets like Ethereum and Bitcoin, rather than fiat currencies. The DAI stablecoin, developed by the Maker Foundation, is the most well-known decentralized stablecoin. DAI algorithmically binds itself 1:1 to the dollar using a collateralized debt position (CDP) currency system. In the CDP system, any accepted collateralized cryptocurrency is deposited into a smart contract in exchange for newly minted stablecoins. Fundamentally, new DAI tokens are loans provided against the collateralized cryptocurrency in the smart contract.
Despite this, CeFi and DeFi also share some similarities.
"The most important practical use case for both DeFi and CeFi is the ability to generate returns from global pools of capital and liquidity; as long as they can connect to the internet, almost anyone can access these funds and liquidity, enabling users previously shut out by the financial system to access a range of financial products they had not used before," says John Patrick Mullin, co-founder of Mantra DAO. (Note: Mantra DAO is a community-managed DeFi platform for lending and governance.)
The difference lies in how services in each segment seek to provide access.
3. The Role of CeFi in the Crypto Space
Although the centralized features of CeFi contradict the original idea of cryptocurrency, it has indeed played a crucial role in crypto applications. Here are some areas where experts believe CeFi is useful:

1. Familiar User Experience
   As mentioned earlier, some aspects of CeFi share a certain degree of similar design with the traditional financial sector, lowering the entry barrier for new crypto users.
   Katherine Deng, Vice President of Global Business at MXC Exchange, states that cryptocurrency is a complex topic, and to become mainstream, it must be simplified, which is precisely what CeFi does.
   Katherine Deng says, "By design, CeFi businesses can attract and serve new crypto users who are already familiar with the user experience of traditional finance, and expecting them to suddenly switch to using DeFi to manage their own risks would be a significant challenge."
   The familiar user experience is akin to what financial institutions do for their clients, as CeFi services host users' crypto assets. This makes learning to use crypto assets easier.
2. Cross-Chain Trading
   There are currently several cryptocurrencies on the market, with leading ones including Bitcoin, Ethereum, Litecoin, Ripple, Zcash, etc. It is common for crypto users to exchange one currency for another, just as people exchange dollars for euros. However, the process of trading two cryptocurrencies from different blockchains is not as straightforward as using different fiat currencies.
   "You cannot just deposit Bitcoin on the Ethereum blockchain to get Ether. The Bitcoin blockchain is different from the Ethereum blockchain, and they do not have interoperability," emphasizes Adam O'Neill, Chief Marketing Officer of crypto exchange Bitrue.
   "CeFi allows for cross-chain trading, which means, theoretically, you can trade any two cryptocurrencies with each other," O'Neill says. "It also allows users to purchase cryptocurrencies using fiat currencies like dollars, making it easy for users to acquire their digital currencies."
   O'Neill adds, "Achieving cross-chain trading with DeFi is challenging because many decentralized protocols exist on the blockchain, thus limiting to crypto assets supported by the relevant blockchain network. For example, DeFi protocols restrict servers built on the Ethereum blockchain to only support Ether and other crypto assets originally issued on the Ethereum blockchain."
   On the other hand, the large volume of orders maintained by CeFi exchanges makes simulating cross-chain trading easier.
3. Higher Operational Efficiency
   "In principle, CeFi is very efficient. You only execute once, and there is no need to reach consensus," says Alex Batlin, CEO of wallet provider Trustology.
   Efficiency is possible because centralized financial services do not execute every transaction on the blockchain. On the other hand, most DeFi applications must be executed on-chain, so CeFi businesses can provide higher liquidity and faster transaction speeds.
   4. What DeFi Brings to the Crypto Market
4. Greater Transparency
   Traditional finance lacks sufficient transparency, especially regarding how financial institutions use customer funds, and crypto companies are trying to address this issue. While DeFi redefines transparency, the CeFi model has only brought slight improvements in this regard.
   Steven Becker, Chairman of the Maker Foundation, points out, "DeFi creates autonomy for people by leveraging the transparency and accessibility of decentralized blockchains, which is used to create financial opportunities."
   Essentially, DeFi provides better operational transparency because decentralized protocols are primarily open-source and can be audited by anyone. Centralized services find it difficult to achieve this.
   Kerr adds, "Unlike CeFi, where a single business operator charges fees from users, any profits derived from DeFi applications will be returned to participants, creating market efficiencies that are difficult to achieve in centralized models."
5. Discouragement of Rent-Seeking Behavior
   Rent-seeking is a concept in economics that occurs when an entity seeks to increase wealth without making any meaningful contribution to productivity.
   This idea stems from the belief that entities derive income from a combination of wages, profits, and rents, with rents being the easiest to obtain among the three. Rent-seeking involves maximizing ownership of resources, which encourages monopolistic behavior. It has been proven that monopolies stifle innovation.
   Experts say this issue does not trouble decentralized services. "DeFi supports innovative financial solutions and how everyone uses these options. But just as there is no freedom without obligation, the cost of DeFi autonomy is the responsibility to manage one's own risks," says Becker.
6. CeFi and DeFi Need Each Other to Grow
   The core concept of DeFi is indeed novel, but the products currently on the market are largely inaccessible to most target markets (those without bank accounts and underbanked individuals). Therefore, DeFi needs the user experience of CeFi.
   "DeFi and CeFi complement each other. They provide more choices for people and institutions, allowing them to leverage their rights and capabilities to create financial opportunities," Becker adds.
   However, Mullin warns that many CeFi projects are "black boxes" and adds that many DeFi protocols are highly speculative.