Centralized finance (CeFi) has been our traditional way of performing transactions since human civilization, centralized finance is simply the reliance on central authorities or third parties to process our financial transactions. In the context of cryptocurrency, centralized finance (CeFi) are exchanges that manage cryptocurrency transactions and activities by acting as a central authority and regulator. All cryptocurrency trading orders are filled up automatedly via Order book in a Centralized Exchange (CEX) in CeFi. CeFi ensures there is liquidity in cryptocurrency tokens or cryptocurrency coins for smooth trading, any cryptocurrency without much transaction volume is delisted from CEX. Centralized exchanges make decisions on which cryptocurrency to list or delist from their exchanges and also the trading fees. CeFi is known to be custodial, CEX controls a user's crypto and this is regulated. The government has set out strict rules and policies for CEX to prevent money laundering and other financial crimes. In CeFi, centralized exchanges have the right to freeze a user's account when the account is flagged fraudulent.
Features of Centralized Finance (CeFi)
1. Interoperability
In decentralized finance, cryptocurrency trading works on only cryptocurrency tokens of the same blockchain. Trading ERC20 tokens can be only exchanged with tokens built on ERC20 (Ethereum blockchain), the same allies to BEP20 (BNB blockchain), TRC20 (Tron blockchain), and all other blockchains. In CeFi, trading, lending, staking, and all other cryptocurrency financial activities are done irrespective of the crypto token’s blockchain. In CeFi, ERC20 tokens can be traded with BEP20 tokens and any other token listed on the centralized exchange in another blockchain. In CeFi exchanges, the conversion of traditional fiat currency to cryptocurrency and vice versa is simple and effortless, demonstrating CeFi's cryptocurrency interoperability.
2. Centralized Exchanges (CEX)
Another feature of CeFi is centralized exchanges (CEX). CEX are online marketplaces for buying and selling cryptocurrencies. Users entrust these "middlemen" to perform trading services on CEX. CEX performs a variety of functions and responsibilities, including lending and borrowing services, cryptocurrency futures trading, and cryptocurrency staking. CEX is regulated and has trading policies that are structured by the government; fraudulent users' assets are seized, and trading profits are taxed depending on the user's government. CEX has advantages and disadvantages, whereas, they have many functionalities that decentralized exchanges (DEX) do not.
Examples of Centralized exchanges:
Binance
Coinbase
Bitmart
Gate.io
FTX
Kraken
Kucoin
Huobi Global
Gemini
Features of Centralized Exchanges
- Fees: One of the features of CEX is Fees, CEX exchanges have very small and negligible trading fees compared to DEX. Fees are induced in actions like trading and withdrawals.
- Usability: CEX has a significant advantage over DEX in terms of usability. When compared to decentralized exchanges, centralized exchanges are much easier to use. Users can easily convert their crypto to FIAT and vice versa.
- Speed: Centralized exchange trading orders are filled compared to decentralized exchanges. This makes centralized exchanges averagely faster than decentralized exchanges. Centralized exchanges use order-book trading technology where bots are set which are willing to buy and sell the token a trader wants to trade.
- Security: There are very few cryptocurrency scams on CEX. CEX is a residual exchange, which means that the exchange owns the user's private key, making security extremely tight. In DEX, a user may lose access to his or her private key or seed phrase and thus be unable to access his or her cryptocurrency wallet. A hacker can also gain access to the location where a user saves his or her private key and steal the user's assets. Scammers create and persuade people to buy fraudulent and fake cryptocurrencies, and people end up getting "rug-pulled." The phrase "pulling the rug out" inspired the name, a developer attracts investors to a new cryptocurrency project and holds a majority of the cryptocurrency tokens. After getting enough investors, the developer withdraws the liquidity of the project. The investors are then left with worthless crypto with no value.
- Custody: In a Centralized exchange, the exchange has custody of the user’s private key and has control over the user's assets. A user has to agree with the terms and conditions of the exchange before using the CEX. A CEX has the right to freeze a user’s assets if it’s termed fraudulent. CEX watches out for cryptocurrency laundering, and once an account is flagged, it’s frozen until the user provides proof of funds and the reason for the transaction. CEX function as our traditional bank in this regard.
- Regulations: Centralized exchanges are regulated and licensed by the government in other to be accepted in a country. There are several countries that don’t accept centralized exchanges because their terms of use, policies, and services don’t abide by the constitution of the country.
Limitations of Centralized Finance (CeFi)
CeFi has a central authority governing our exchange services in CEX. CeFi systems are significantly less risky than DeFi and have insurance as well as strict well-established policies and regulatory safeguards in place to ensure user account privacy and integrity.
In the context of banking services and the standpoint of centralized systems, there is no technical knowledge required to log into your bank account or centralized money transfer apps like Western Union, Skrill, or Neteller. Customer service is provided by centralized platforms, whereas DeFi platforms do not. Regardless, there are a lot of limitations to centralized finance or banking systems.
Transaction fees are unavoidably higher in a CeFi due to the multiple financial intermediaries available. This is one of the primary reasons why millions of people around the world are moving to decentralized platforms. Most CeFi providers may temporarily suspend your account due to a violation of some policies. Most exchanges, however, such as Coinex, allow you to share your USDT, BTC, and other cryptocurrencies at any time, and trade across blockchains with very cheap trading fees.
Summary
In summary, CeFi has its pros and cons. CeFi is responsible for the security of the user's assets in the exchange. There have been instances where CEX has been hacked and users' assets have been stolen, but this is extremely rare. Users who use a non-custodial wallet may lose their private keys and thus lose access to their crypto assets and NFTs. Hackers can also gain access to a user's assets by hacking into the location where the user saves his or her private key. Most of the functions of CeFi can be done automatedly by programmed smart contracts which include P2P trading, trading, staking coins, and earning other tokens on that chain (Yield Farming), etc. CeFi exchange trading is more seamless compared to DeFi and the fees are more in DeFi compared to CeFi. Interoperability is one of the most important features of CeFi, in centralized exchanges, a user can perform cross-chain trading which isn’t possible in DeFi.
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