Decentralized finance (DeFi) has grown in popularity to become a billion-dollar market that offers users the same financial products found in traditional finance (TradFi), along with additional opportunities. These are liquidity provider fees or governance tokens earned through yield farming. However, the lack of regulation in DeFi has raised many concerns about criminals using protocols to launder money and fund illegal activities. This is where CeDeFi comes in.
Read on to find out what CeDeFi is and how it compares to DeFi and CeFi.
What is CeDeFi?
CeDeFi stands for centralized decentralized finance, a term referring to a financial system that merges the features and benefits of CeFi and DeFi.
Therefore, CeDeFi offers the DeFi products as agricultural yieldlending, borrowing, liquidity staking, and token trading, which are available on DeFi protocols while complying with regulations.
CeDeFi solves the lack of regulation in the crypto space. It does this by complying with regulations that help law enforcement identify potential criminals in an easier way.
CeDeFi is also characterized by centralized entities that use similar governance structures known from the traditional financial sector. Nevertheless, it encompasses the efficiency of decentralized finance, thereby reducing costs.
Binance’s role in the creation of CeDeFi
One of the largest centralized crypto exchanges, Binance, launched its own blockchain in April 2018. The goal was to create a network with high throughput and capable of processing many transactions per second. The blockchain was named Binance Chain (later renamed to the BNB beacon chain).
The network used the Tendermint consensus model and focused on one main app, Binance DEX, rather than multiple apps. However, DeFi was thriving on Ethereum, and the Binance DEX was not doing much traction. As a result, Binance realized it needed a blockchain that supported smart contracts and allowed other developers to build decentralized applications (DApps) if that chain was to compete with Ethereum.
Thus, Binance forged the Ethereum client Go (Geth), creating Binance Smart Chain in September 2020 (now called BNB Smart Chain). The new blockchain ran alongside the BNB Beacon chain and supported smart contracts. Additionally, it had a different consensus mechanism, block time, and gas limit per block than Ethereum.
The BNB smart chain has compromised decentralization to achieve scalability and with it, high transaction throughput. It has adopted the Proof-of-Staked-Authority (PoSA) consensus model. This consensus mechanism does not just allow anyone to start validating transactions on the network as certain restrictions have been put in place.
BNB Smart Chain only allows the top 21 active validators ranked by the number of BNB they have staked to take turns confirming blocks. Validators do not earn a block reward. Therefore, the limited number of validators makes BNB Smart Chain a more centralized blockchain network and subsequently a good example of CeDeFi.
That said, Binance plans to improve decentralization and censorship resistance through BEP131, a network Upgrade which will increase the number of validators from 21 to 41.
DeFi vs CeFi vs CeDeFi – A Comparison
|Know Your Customer (KYC)||There are no KYC requirements||KYC is required||KYC is required|
|Keep||Noncustodial, meaning users own their private keys||Custodial, which means the platform holds the private keys||CeDeFi protocols are not custodians|
|Governance||Decentralized since there is no central authority||centralized||centralized|
|Regulatory conformity||Does not comply with regulations||Complies with the regulations of the country where the platform is located||CeDeFi platforms comply with the regulations of the laws of the jurisdictions in which they operate|
|Intermediaries||Smart contracts replace intermediaries||Third parties are involved||Intermediaries interacting with smart contracts|
|Security||Smart contract bugs could be exploited||Platforms are susceptible to security breaches||Exploitation of smart contract bugs is possible|
Centralized Finance (CeFi) refers to platforms that offer crypto products and services but retain a traditional financial governance structure. The entities behind these platforms make decisions behind closed doors without involving their customers. Users must also follow the rules administered by CeFi platforms.
Service providers under this financial model offer users hot wallets to store their crypto assets. However, they control the assets of their users as they hold the private keys to the crypto assets. This explains why centralized crypto exchanges can suspend withdrawals of digital assets, and users can do nothing but wait for the suspension to be lifted.
CeFi platforms comply with the regulations of the jurisdictions where they are established. Common compliance requirements include KYC, Anti-Money Laundering (AML), and Countering Terrorist Financing (CFT).
Decentralized finance (DeFi) is a financial system that seeks to remove control from CeFi platforms over crypto users. Therefore, they give users the freedom to control their own wallets and the digital assets they hold.
DeFi protocols operate entirely in code, meaning no regulatory compliance is required, and users interact with smart contracts to access financial products such as lending, borrowing, trading, farming yield, liquidity staking, and token transfers from one network to another via bridges (which are still mostly centralized). DeFi is also more accessible as users do not have to complete KYC, AML, and CFT requirements. All they have to do is connect a wallet to use a DeFi protocol without providing any personally identifiable information.
CeDeFi protocols use smart contracts, just like DeFi, thus providing customers with DeFi services. However, most CeDeFi platforms retain control of user funds in one way or another. However, some CeDeFi companies allow users to interact with them in a non-custodial manner.
At the same time, CeDeFi platforms are generally regulatory compliant and their governance model is centralized. As a result, it combines the non-custodial nature of DeFi with the compliance found in CeFi.
CeDeFi platforms may lean more towards centralization than decentralization. Besides Binance, Unizen, CoinZoom Nexo, Bybit and Midas Investments are examples of CeDeFi platforms.
Advantages of CeDeFi
- Regulatory conformity : CeDeFi platforms generally comply with KYC, AML and CFT regulations.
- No intermediaries: Users interact with smart contracts instead of intermediaries.
- Reduced costs: The costs associated with the involvement of intermediaries are eliminated, which reduces overall costs.
- Institutional Adoption of Crypto: CeDeFi can promote institutional adoption of crypto due to the inclusion of regulatory compliance.
- Improved asset control: Some CeDeFi models allow users to have more control over their digital assets than CeFi users because their wallets are not custodians.
- Faster transaction speeds: CeDeFi platforms will likely choose scalability over decentralization. This means that they will offer faster transactions per second.
Disadvantages of CeDeFi
- This is relatively new: CeDeFi platforms are relatively new and few in number. Their success is also unproven.
- Beginners may find DeFi products difficult to use: DeFi products are not easy to understand and may require some initial research from crypto newbies.
- Centralization could increase the risk of attacks: Highly decentralized blockchain networks are likely to be more secure than their centralized counterparts. For example, BNB Smart Chain suffered a offensive in October where millions of dollars were stolen. Additionally, several projects built on the BNB smart chain were attacked in 2021.
Is CeDeFi the future of DeFi?
No. Probably not.
As more and more CeDeFi service providers emerge, the DeFi sector will not cease to exist because it offers advantages that neither CeFi nor CeDeFi can offer. For example, the lack of KYC requirements in DeFi increases the level of user privacy. This is a merit that cannot be overlooked as privacy becomes increasingly important to users in the digital space.
Additionally, users can more easily access financial products through DeFi protocols, as KYC is not required. This is called permissionless and de facto allows anyone to participate.
The security issues that come with the decentralization exchange may limit the growth of CeDeFi in the long term. Additionally, scalability issues may fade as blockchain technology evolves over the years. Therefore, it will no longer be necessary to give up decentralization to gain scalability. This could mean that an intermediary financial system mediating between CeFi and DeFi will no longer be essential.
Regarding investor protection, most future DeFi protocols could implement insurance policies to protect users in the event of theft. These future protocols may also have solutions to criminal activities without the need to involve regulators.