The financial innovation brought by DeFi requires CeFi’s user experience.
Original title: “Forbes in-depth analysis: the growth path of CeFi and DeFi”
Written by Oluwaseun Adeyanju, columnist of Forbes Magazine Translation: Kava Labs
From the perspective of crypto enthusiasts, the financial system has two halves-traditional finance and cryptocurrency finance. But there are now two sub-spaces in the crypto field-Centralized Finance (CeFi) and Decentralized Finance (DeFi). The following is an interpretation of how differentiation occurs.
One of the original ideas behind cryptocurrency is to have a complete peer-to-peer network that does not require centralized intermediaries such as financial institutions. However, the performance of the event in reality is different.
First, there are two ways to own cryptocurrency. You can receive payments in cryptocurrencies, or you can exchange them in fiat currencies, such as U.S. dollars. Most people enter the market through fiat currency, which complicates things—at least involves the idea of circumventing financial institutions. Most countries have anti-money laundering regulations, which makes financial service providers responsible for preventing illegal use of their platforms.
Therefore, the service that allows people to exchange fiat currency for cryptocurrency has become a constraint of current regulations. Some governments (such as China and Japan) severely crack down on cryptocurrency exchange operations.
Second, in a world where encryption is entirely peer-to-peer, everyone will be responsible for managing their own risks, because there is no centralized organization in between. Users must protect their private keys. If the private key is lost, it will cause irreparable loss of their digital assets.
This is different from the experience of consumers in traditional financial companies. The money deposited in the bank is protected by insurance. Therefore, a familiar setting becomes necessary.
These two challenges together led the early development direction of the encryption field, namely CeFi.
As the crypto market developed into a multi-billion dollar market, some markets that wanted greater flexibility and a wider range of choices began to build financial services that rely on self-executing computer algorithms called smart contracts. In some cases, a decentralized community of entities or participants determines how the service runs. This is the basis of decentralized finance.
What is CeFi?
As the name suggests, CeFi consists of a financial system in which users deposit their funds to third-party entities. Users of CeFi services essentially believe that those who manage the business can uphold high ethical standards. This trust function is also imported from the traditional financial field. In addition, it is worth noting that according to Pokket CEO Bill Dashdorj, the term CeFi exists in the context of cryptocurrency.
“CeFi is an extension of the existing financial model, but it has been upgraded to a new level with encryption technology,” Dashdorj said. “It alleviates one of the biggest pain points of the traditional financial system-accessibility, but maintains usability and simplicity because it is more familiar to most people.”
In Dashdorj’s view, “CeFi is a breaker of financial service barriers. It provides more direct needs for people who are not satisfied or cannot access traditional financial services.”
Examples of CeFi services include centralized exchanges such as Coinbase and Binance. Like Coinbase’s USDC and the Libra stablecoin to be dominated by Facebook are also CeFi services. These stablecoins belong to the CeFi category because they are backed by the U.S. dollar one-to-one and managed by a centralized organization.
Crypto savings and lending services like BlockFi, Celsius, and Pokket are also centralized financial companies. Generally speaking, CeFi refers to any kind of service in which you have to keep the private keys of the encrypted assets you claim to own.
The only decentralized part of CeFi is that these services build use cases for decentralized cryptocurrencies such as bitcoin, ether, and litecoin.
What is DeFi?
Brian Kerr, CEO of DeFi platform Kava Labs, said that the core idea behind DeFi is to bring complete decentralization to the encryption ecosystem.
“Unlike CeFi services, DeFi protocols and applications are open source and run in the cloud by many operators around the world,” Kerr said. “The software has become open, anyone can use it as long as they have access to the Internet, and there is no need for KYC or cumbersome access procedures similar to traditional financial circles.”
In other words, DeFi services are permissionless and trustless.
Experts believe that the freedom provided by DeFi is accompanied by users’ responsibility to manage their own risks. Compared with CeFi, users of DeFi applications are mainly responsible for their private keys.
In addition, DeFi services are not foolproof. A recent report by Ciphertrace, a crypto intelligence company, shows that between January and the end of October, approximately $98 million worth of cryptocurrency was lost by hacker attacks against decentralized financial protocols. In the first half of November, the situation got worse, the DeFi service Akropolis lost more than 2 million US dollars due to hacker attacks.
Examples of DeFi services include decentralized exchanges such as Uniswap and dYdX. Through these services, users connect their self-custodial crypto wallets to exchanges for trading. There is no central entity to hold and manage users’ assets. Algorithms and autonomous lending services such as Compound and bZx also belong to the DeFi category.
There are also stablecoins in the DeFi half of the crypto universe. DeFi stablecoins are backed by decentralized encrypted assets, such as Ethereum, Bitcoin, etc.-not government-issued currencies.
The DAI stable currency was developed by the Maker Foundation and is basically the most famous decentralized stable currency. DAI is pegged to the U.S. dollar one-to-one through an algorithm and adopts the mortgage debt position (CDP) currency system. In the CDP system, any accepted mortgage cryptocurrency will be deposited into a smart contract in exchange for newly issued stablecoins. Fundamentally speaking, the new DAI token is a loan given against the encrypted collateral in the smart contract.
However, CeFi and DeFi still have some basic similarities.
“The most important practical application of DeFi and CeFi is the ability to generate returns from global capital pools and liquidity. Almost anyone can access these capital pools and liquidity as long as they have access to the Internet.” Co-founder of Mantra DAO John Patrick Mullin said that Mantra DAO is a community governance DeFi platform for staking, lending and governance.
“These developments allow users who may have been excluded from the financial system to access a range of financial products that they have never had before,” Mullin added.
The difference lies in how the services of each subspace seek to provide access.
The role of CeFi in encryption
Although CeFi’s centralization feature goes against the original intention of cryptocurrency, it does play an important role in making cryptocurrency usable. The following are some areas where experts find CeFi useful.
Familiar user experience
As mentioned earlier, the design of some aspects of CeFi is somewhat similar to the traditional financial sector, which to a certain extent makes it easier for new crypto users to get started.
Katherine Deng, vice president of global business of MXC exchange, said that cryptocurrency is already an esoteric topic. If it must go mainstream, it must be simplified. This is what CeFi does.
“By design, CeFi companies can attract and serve new encrypted users,” Deng said. “These users are already familiar with the user experience of traditional finance. If they are expected to suddenly jump to using DeFi to manage their own risks, this will be a big requirement.”
Part of the familiar user experience is that the CeFi service keeps encrypted assets for users, just like financial institutions keep funds for customers. This makes the learning curve for adopting encryption technology less steep.
Cross-chain transaction
There are only a handful of cryptocurrencies on the market. The top rankings include Bitcoin, Ethereum, Litecoin, Ripple, zcash, etc. It’s very common for crypto users to exchange one type for another-just as people exchange dollars for euros. However, the transaction process of two encrypted currencies on different blockchains is not as simple as different legal currencies.
You cannot get Ether (the native currency of the Ethereum blockchain) just by depositing bitcoin on the Ethereum blockchain. Adam O’Neill, chief marketing officer of the crypto exchange Bitrue, emphasized that the Bitcoin blockchain is different from the Ethereum blockchain in that they cannot be interoperable.
“CeFi allows cross-chain transactions, which means that, theoretically, you can trade between any two cryptocurrencies,” O’Neill said. “It also allows users to purchase cryptocurrencies with their US dollars and other fiat currencies, providing them with an easy way to obtain their digital currency.”
O’Neill added: “Cross-chain transactions are difficult to achieve through DeFi, because many decentralized protocols are attached to the blockchain, so they are restricted to only accept encrypted assets supported by the relevant blockchain network. For example. , The DeFi protocol built on the Ethereum blockchain is limited to only support Ethereum and other assets originally issued on the Ethereum blockchain.”
On the other hand, CeFi Exchange maintains a huge order volume, making it easier to simulate cross-chain transactions.
Higher operational efficiency
“In principle, CeFi can be very efficient. You only need to do it once, and you don’t need to reach a consensus.” said Alex Batlin, CEO of wallet provider Trustology.
The high-efficiency implementation here is possible, thanks to centralized financial services that do not execute every transaction on the blockchain. Most DeFi applications must execute transactions on the chain. Therefore, CeFi companies can provide higher liquidity and faster transaction speed.
What does DeFi bring to the crypto market?
Greater transparency
The lack of sufficient transparency in traditional finance, especially with regard to how financial companies use customer funds, is a problem that encryption technology is trying to solve. The CeFi model can only bring marginal improvements in transparency, while DeFi redefines transparency.
“DeFi creates autonomy for people by leveraging the transparency and accessibility of decentralized blockchains; this autonomy is used to create financial opportunities,” noted Steven Becker, chairman of the Maker Foundation.
In essence, DeFi provides better business operation transparency, because most decentralized protocols are open source and anyone can review them. This is almost never the case with centralized services.
Kerr added: “Compared with CeFi, in CeFi, a single commercial operator charges users a fee, and any profits generated by DeFi applications will be returned to participants. This creates a market efficiency that is difficult to achieve in a centralized model.”
DeFi prevents rent-seeking behavior
Rent-seeking is a concept in economics. Rent-seeking occurs when an entity pursues an increase in wealth without making any meaningful contribution to productivity.
This idea comes from the belief that the income of an entity comes from one or a combination of wages, profits and rents. Among these three types of income, rent is the easiest to obtain. Rent involves the maximization of resources, which encourages monopolistic behavior. And monopoly has been shown to inhibit innovation.
Experts say that this issue does not bother decentralized services.
“DeFi innovates the available financial solutions and how everyone consumes these choices. But just as there is no freedom without obligation, the price of DeFi’s autonomy is the responsibility to manage your own risk.” Becker said.
CeFi and DeFi need to grow with each other
The core concept of DeFi is indeed novel, but the products currently on the market are mostly unavailable for most target markets-people with no bank accounts and insufficient bank accounts. To this end, DeFi needs CeFi’s user experience.
“DeFi and CeFi complement each other. They provide people and institutions with more choices, enabling them to use their power and capabilities to create financial opportunities,” Becker added.
However, Mullin cautioned that many CeFi projects are “black boxes,” adding that many DeFi agreements are highly speculative.
Source link: www.forbes.com
