Customers are frequently unaware of the underlying rules or agreements that govern financial assets and products, therefore the traditional centralized finance (CeFi) ecosystem may look confusing to non-experts.
Decentralized Finance (DeFi), on the other hand, is making a name for itself as an ecosystem that promises transparency and control, due in part to the underlying integrity-protected blockchain and greater financial asset returns than CeFi systems. However, the distinction between CeFi and DeFi is not always clear.
The most prevalent DeFi vs CeFi properties are discussed in the section below.
While the underlying DeFi application code might not always be open-source, non-custodial DeFi must have publicly verifiable execution and bytecode on a blockchain. Therefore, unlike CeFi, each DeFi user may see and confirm that DeFi state changes are carried out properly. The new DeFi technology has an unmatched ability to transfer trust because of this openness.
Sequential actions, including several financial transactions, may be carried out as part of a blockchain transaction. This combination can be made atomic, which means that the entire transaction will either succeed or fail simultaneously. CeFi does not have this programmable atomicity property, although it may be possible to enforce atomicity in CeFi through expensive and time-consuming legal agreements.
Anonymous development and deployment
Less privacy is offered to users by centralized finance than by DeFi transactions. Even Bitcoin’s creator has remained unknown up to this point, and many DeFi initiatives are developed and run by anonymous teams. Once they are implemented, the DeFi smart contracts are run implicitly by the miners. Without a front-end, anonymous DeFi applications can operate, forcing users to interact with the smart contract directly.
DeFi, as opposed to CeFi, enables users to instantly control their assets (there is no need to wait for the bank to open). But with immense power also comes great responsibility. Users face the majority of technology risks unless such insurance is underwritten. As a result, holding cryptocurrency assets is particularly common with centralized exchanges, which are essentially the same as traditional custodians.
Trading of crypto assets
The CEXs are constructed using the same principles as their traditional equivalents. Limit order books are off-chain records of pending trades that CEXs maintain. AMM protocols are used by decentralized exchanges (DEXs) to match the counterparties in a transaction, which is how they operate substantially differently from centralized exchanges. Depending on the volume of transactions, AMMs use mathematical algorithms to set prices.
Execution order malleability
When using permissionless blockchains, users frequently use a peer-to-peer network to publicly disclose the transactions they want to carry out. Because there is no persistent centralized entity directing the sequence of transaction execution, peers might, for instance, engage in competition for transaction fee offers. This order malleability has led to the demonstration of several market manipulation strategies that are presently used often on blockchains.
On the contrary, regulatory organizations in CeFi establish stringent requirements on financial institutions and services, such as how transaction ordering must be implemented. However, this is conceivable due to the centralized nature of CeFi’s financial intermediaries.
Blockchains in general and DeFi’s transaction fees are essential for preventing spam. However, financial institutions in CeFi have the option to provide transaction services for free due to the ability to depend on client anti-money laundering (AML) verifications (or are compelled by governments to offer some services for free).
Non-stop market hours
Markets on CeFi are renowned for having outages. For instance, the two main trading exchanges in the United States are the New York Stock Exchange and the Nasdaq Stock Exchange. Their business hours are 9:30 am to 4:00 pm Eastern Time, Monday through Friday.
Because of the nonstop nature of blockchains, most, if not all, DeFi markets are open 24 hours a day, seven days a week. As a result, DeFi lacks pre-and post-market trading, in contrast to CeFi, where liquidity on a variety of goods is generally thin during these times.
Only blockchains with non-privacy-preserving smart contracts can include DeFi. As a result, rather than offering actual anonymity, these blockchains offer pseudo-anonymity. These exchanges have the authority to disclose address ownership to law enforcement given that centralized exchanges with AML standards are typically the only feasible alternative for converting money to cryptocurrency assets.
In order to reduce the danger of price fluctuations, an arbitrage should ideally work atomically. Arbitrage on centralized and hybrid exchanges is inherently vulnerable to fluctuations in market pricing unless the arbitrageurs are working with the exchanges to ensure execution atomicity.
Arbitrage between two decentralized exchanges on the same blockchain can be considered risk-free when transaction costs are ignored. This is due to the atomicity feature of the blockchain, which enables traders to create a smart contract that conducts the arbitrage and reverts if the arbitrage is unsuccessful. Arbitrage risk between two DEXs on different blockchains is equivalent to that of a CEX and hybrid exchange.