It won’t be difficult for those familiar with the crypto industry to decrypt the term CeDeFi, which literally means centralized decentralized finance. The DeFi sector has gained so much popularity over the past two years that influencers in the crypto industry were announcing that DeFi would replace centralized finance. However, instead of absorption, we see a combination of these sectors, complementing each other and making crypto financial instruments more accessible and user-centric.
In this blog post, we will highlight how these adjacent financial sectors work together, the advantages and disadvantages of CeDeFi, and examine several projects that are worthy of attention.
What are the DeFi and CeFi sectors?
Before the advent of blockchain technology, financial services were available only through state and private banks, international payment systems, and other fintech institutions. With the popularization of crypto and blockchain, new financial opportunities opened up, affording users almost instantaneous global and cheap transfers, the ability to access complex financial products without the difficult forms and usual barriers linked to things such as credit scores. With blockchain, anyone can create and use an application combining various elements (stablecoins, exchanges, oracles, and so on).
The flexibility and opportunities for users to quickly assemble a diverse portfolio of assets has caused worry and pushback in some traditional quarters, but more and more we are seeing centralized providers incorporate crypto assets into their services. To understand how CeFi and DeFi are merging into the new CeDeFi sector, we must first take a closer look at both sectors, their key challenges and advantages, and what solutions their merger offers.
What is CeFi?
CeFi or centralized finance is a service primarily created for buying, selling, and swapping cryptocurrencies, with users’ personal information held by the organization in a centralized repository. The most common example of CeFi is the centralized crypto exchange, where users sell, buy or exchange cryptocurrencies with a third-party intermediary. The user entrusts the storage, exchange, and management of funds to trading platforms, which store user funds in custodial wallets and are responsible for them.
CeFi services operate according to the authority of the jurisdiction under which they operate. To use centralized financial services, the user must pass the ‘Know Your Customer’ (KYC) process. As another prerequisite, centralized crypto exchanges are also required to implement the ‘Anti-Money Laundering’ (AML) policy.
The main disadvantages for users when using centralized services are:
- Funds don’t belong to users – Funds on personal accounts aren’t completely controlled by the user. Access to funds and personal data in centralized storage means you need to really believe the exchange is reliable. A crypto exchange may suspend the withdrawal of funds at any time, go bankrupt, or simply disappear, taking all assets and there is nothing that can be done.
- Security – Throughout the history of crypto exchanges, there have been many times where hackers have attacked and stolen users’ personal data and account details from centralized storage. In this situation, the user cannot protect themselves in any way, with the only hope being compensation from the crypto exchange itself. However, as practice shows, major hacks lead to the closure of exchanges, and users can often say goodbye to their funds.
- Verification – Without full KYC, the user can’t access all services. Many users are dissatisfied with data verification and consider this a violation of the anonymity principle in blockchain technology. That is why users look for alternative solutions in DeFi crypto exchanges.
Despite the risks listed above, the centralized finance sector is still used by many people who are satisfied with the level of service provided.
What is DeFi?
DeFi, or decentralized finance, is an open financial ecosystem based on blockchain technology, encompassing digital assets, smart contracts, decentralized applications, and more. Smart contract development allows developers not only to buy, sell and exchange cryptocurrencies, but also opens up access to more complex functions such as lending, yield farming, and others.
Users have access to financial services through dApps, which are not controlled by the state (although in many countries, users are required to declare and pay tax on crypto gains), and are written using smart contracts. In addition, in the DeFi sector, there is a form of so-called collective ownership – DAO, which you can read more about in our recent blog post.
The key advantages of the decentralized finance sector are:
- Globality. dApps are a global financial product, which provides equal access to users around the world, regardless of their location or documentation status; although Internet availability is of course still a prerequisite.
- Transparency. Transactions made in DeFi applications are public; any user can access the code at any time, thanks to the transparency of blockchain technology. By auditing smart contracts, the user can be sure that it is secure, which helps to establish trust.
- Autonomy. The deployment of smart contract functions doesn’t require human control or intervention, making them completely autonomous. The transaction rules are written in code, which excludes any violations, and only requires updates if the developer considers it necessary. Even in this case, projects are often subject to community voting, which means the developer can’t just make changes based on their own wishes.
Although DeFi is a revolutionary concept, it is impossible to completely replace centralized finance in the crypto industry. That being said, there is an opportunity to combine the best parts of both DeFi and CeFi, resulting in what is called CeDeFi.
The emergence of CeDeFi
Before discussing CeDeFi’s benefits, let’s first look at DeFi’s issues that led to the merger with CeFi, and how both sectors can be made stronger through their convergence.
Similar to the security danger involved in centralized repositories of information, DeFi also presents some problems in this area. In 2021, according to the CertiK 2021 State of DeFi Security Report, the amount of funds stolen by hackers from the DeFi sector reached $1.3 billion, which is 2500% more than in 2020. Although these numbers may cause some alarm, we should also acknowledge that the amount locked in DeFi projects was (US)$18.76 billion at the start of 2021, versus $245 billion at the end, meaning the rise in stolen funds came from a much larger pool.
The anonymity of transactions and wallet holders in the DeFi sector makes it almost impossible to track down and catch hackers. It also hurts investment, as institutional investors are discouraged from entering an industry where counterparties are anonymous.
The market boom and the increase in the DeFi sector’s TVL to $245 billion (or 13 times that of the year before) has led to a rise in interest from regulators, who believe that a thorough legal structure is needed. DeFi projects, in most cases, face regulatory issues from authorities and affect DeFi exchanges that cannot work in many countries due to a range of rules and AML policies.
Another problem with many DeFi platforms in their current format is the complex user interface. This makes them less accessible due to the high degree of technical knowledge required to use them, leading to a limited expansion of a project’s user base, holding back increased growth.
Although there are currently efforts to improve this, presently users of DeFi platforms lack the ability to use the functions of one dApp on two different blockchains. For dApps to gain all the benefits of interoperability, they need to scale with the experience of the CeFi sector.
Based on the issues above, the following benefits from the DeFi/CeFi merger can now be examined:
With the convergence of centralized and decentralized finance, thanks to AML and KYC, regulators will be able to more easily control the legal movement of funds. This will lead to mass adoption and use of dApps through the oversight of regulatory authorities. In addition, with a significant turnover of funds, the problem of trust and regulation will disappear, including for institutional investors, because both parties will know who is behind a project.
The security audit model and best practices can be taken from CeFi and adapted to DeFi. The merger will reduce vulnerabilities in the decentralized sector by applying audit methods that will evaluate projects and conduct a critical audit before deploying a new protocol. This will increase security in launching more CeDeFi projects.
CeFi platforms are used by a much larger number of people due to their convenience and similarity to financial instruments familiar to those in the world of traditional finance. These features can be transferred to DeFi protocols to improve user acquisition and retention.
Last but not least, a huge advantage that CeDeFi brings into the crypto-financial sector is interoperability. CeDeFi provides cross-chain interoperability by allowing access to financial instruments from different blockchains. For example, it will be possible to stake using multiple assets and reward liquidity providers with tokens from several projects deployed on other blockchains.
Although DeFi is slowly taking over the cryptocurrency industry, CeFi is still the most significant player. With the experience of managing large capitals of centralized finance, the integration is extremely beneficial to the growth of the DeFi ecosystem.
Despite the positive prospects for the integration of these financial sectors, there are some concerns, such as monopolization. There is a risk that powerful organizations may try to take over a CeDeFi protocol and its funds by absorbing existing protocols from other blockchains.
As the main aim of blockchain and DeFi as part of Web 3.0 is decentralization, It is important to ensure that the centralized aspects are controlled, and don’t negate the benefits that decentralization brings, such as true ownership. It is easy to see how large corporations or nation states could co-opt and compromise the independence of large blockchains, like Ethereum.
Another theoretical concern comes if we imagine CeDeFi platforms that are accessible, user-friendly and free from any security issues. What will happen when more and more people flock to these platforms? Mass investment in a rapidly fluctuating coin could cause economic issues that have a strong ripple effect throughout society. Cryptocurrencies remain experimental, so are we really prepared for mass adoption?
Top CeDeFi projects to watch out for
Here are several CeDeFi projects that successfully combine the advantages of centralized and decentralized finance.
Binance Smart Chain
Changpeng Zhao is the founder and CEO of the largest centralized crypto exchange in terms of trading volume. CZ first outlined the word ‘CeDeFi’ and introduced the first blockchain with full CeFi and DeFi interoperability, but let’s talk about everything in order.
Binance Chain was launched in April 2019 to develop secure, decentralized cryptocurrency trading. However, on this blockchain, there was no possibility to deploy smart contracts and, therefore, dApps. Binance Smart Chain was created to solve the problem of blockchain scalability without sacrificing decentralization and security.
Binance Smart Chain is a new blockchain for easy dApp development that is fully cross-chain compatible with Binance Chain. Binance Chain enables fast asset trading, and BSC deploys dApps, giving users access to an ecosystem with multiple use cases.
In addition, BSC is compatible with the Ethereum Virtual Machine (EVM), which allows for the running of the same smart contracts and dApps as on Ethereum. To transfer coins from one blockchain to another, “pegged” coins are used, the value of which corresponds to the current market rate. The scalability of Binance Smart Chain allows you to use assets from different blockchains in the DeFi space.
OpenOcean is another CeDeFi project rapidly gaining popularity among traders. OpenOcean is the world’s first full aggregation protocol that enables cross-chain swaps for crypto trading that sources liquidity from DeFi and CeFi markets. Applying a deeply optimized intelligent routing algorithm, OpenOcean finds the best price and provides the lowest slippage for traders on aggregated DeFi and CeFi, with no additional fees.
The existing OpenOcean interface is easy to use and completely free for users; traders pay only gas and exchange fees. Also, OpenOcean provides an API and a customizable trading interface for professional traders. The protocol aggregates DEXes and CEXes across Ethereum, Ethereum Layer 2 (Loopring and Polygon), Binance Smart Chain, which we described above, Solana, HECO, Ontology, and TRON. It is the first full aggregator on Ethereum Layer 2, TRON, and Binance Smart Chain and exchange.
At the beginning of December 2021, OpenOcean developers announced the integration of the Arbitrum scaling solution with all the leading decentralized marketplaces on the network. Now users have the opportunity to trade at the most profitable rates with low commissions on Top DeFi exchanges such as UniSwap v3, SushsiSwap, Curve, and others.
Unizen is a smart CeDeFi ecosystem that combines centralized and decentralized infrastructure to connect both sectors through a modular ecosystem. Unizen’s innovations are focused on hybrid liquidity, high security, and a user-friendly interface that is intuitive for beginners and efficient for experienced traders.
The Unizen team has developed a unique CeDeFi solution for integrating trading instruments and exchanges on one platform. This solution will help traders reduce risk by interacting with proven assets with deep liquidity and reducing the decision-making process time. The Unizen architecture, based on the CeDeFi approach, allows users to purchase any digital assets and find the best trade based on liquidity depth, withdrawal and network fees.
The CeDeFi concept has begun to gain momentum. It promises the ultimate way to allow both newbies and experienced users to trade on secure exchanges, with carefully selected and verified projects with high liquidity.
Currently, the crypto industry needs synergy between DeFi and the CeFi financial system. This synergy is CeDeFi. The combination of DeFi principles without a governing body, where decisions are made democratically and agreed upon by the community, together with the security measures and ease of use provided by CeFi, will facilitate the mass adoption of cryptocurrencies, which will ultimately lead to an optimal financial environment. Despite the differences between CeFi and DeFi sectors, both ecosystems are mutually beneficial and are likely to succeed through integrated solutions. Noting this, the decentralization trade offs required to keep all parties happy may come at cost as protocols attempt to fit into the structure of the decentralized web, or Web 3.0.
While we are always anticipating new projects and technical developments, we are also working hard to contribute to these changes ourselves through the projects we undertake at INC4. We are engaged in both the development and audit of existing projects, and are successfully integrating faster, more secure, and fully transparent solutions from the DeFi and CeFi sectors for a range of different clients. Contact us for a free estimate regarding your project.