DeFi vs CeFi: Centralized finance crypto lenders under pressure

What is the difference between CeFi and DeFi crypto loans?

CeFi vs DeFi                                 
What differs DeFi and CeFi when it comes to crypto loans? - Photo: Shutterstocl
                                

With the ongoing worldwide inflation crisis, centralized lending institutions look like they might, potentially, be coming under pressure. This does raise the question, though, as to whether taking out a loan through decentralized lending platforms might be a better idea. Let’s take a look and see what the issues in this particular CeFi vs DeFi discussion are as well as answering the questions “what is DeFi?” and “what is CeFi?”

DeFi explained

One of the biggest drivers behind the growth of blockchain technology is the concept of decentralized finance, or DeFi for short. Ultimately, a DeFi transaction is a financial transaction that bypass banks. Let’s note that Bitcoin – the daddy of all crypto coins – was set up in the wake of the global financial crisis of the late 2000s to allow people to get access to the services they needed without having to worry about conventional banks. 

The World Bank says there are 1.7 billion people who do not have a bank account, but roughly 66% of them own a mobile phone. Advocates of decentralized finance hope to reach these people, which will, it’s hoped, promote financial inclusion.

The aim is to come up with a fairer version of traditional financial services, accessible online. Decentralized finance has the goal of providing a modern, fairer alternative to all of these services that can be accessed over the internet. These tools are often available in the form of decentralized apps, or DApps for short.

Anyway, one of the financial services that can be provided by DeFi that mirrors what is available in conventional, centralized finance (CeFi) is loans. The market for crypto-based DeFi loans has grown recently, with the likes of AAVE, and MakerDAO all coming to prominence.

How DeFi can (sometimes) be CeFi

Something else that should also be mentioned is that the division between DeFi and CeFi is not, necessarily, binary. For instance, in June 2022, perhaps the biggest story in the world of cryptocurrency was when the Celsius crypto lending platform ended up barring withdrawals in a move that pretty much confirmed that cryptocurrency was in a bearish market. Now, it might seem reasonable to assume that, since Celsius existed on the blockchain, that it was a DeFi lending platform. Things were not so simple, however. Because Celsius had a named team in charge of it, led by CEO Alex Mashinsky, there was a case to be made that it was, actually, a CeFi platform that just so happened to specialize in crypto loans. On the other hand, because it operated on the blockchain, there was a case to be made that it was, in fact, a DeFi lender. While, when we talk about  traditional, fiat based, lenders we will use CeFi and DeFi will be used for more anonymous, crypto-based platforms, there will be times when the lines are blurred. For instance, should the Compound system, which pioneered crypto loans, be called CeFi or DeFi? That all depends on how you look at it.

Anyway, it is worth noting that other organizations that appeared to bridge the DeFi vs CeFi divide, such as the Three Arrows Capital hedge fund also ran into problems when it came to the impact of the market weakening. On the other hand, though, what might be termed as pure DeFi networks did not escaped unscathed, with the restrictions placed on the Anchor Protocol platform proving that point. 

So, what are the other differences between a DeFi crypto lending platform and a CeFi one? Why might someone want to use the one and not the other? And why might someone want to take out a crypto loan in the first place? Let’s see what we can find out. 

Potential differences

Crypto loans
Crypto loans are back in the spotlight - Photo: Shutterstock

Now, there are some issues with both DeFi crypto loans and CeFi crypto loans. For instance, as of June 2022, inflation is very high. This means that there is a risk people may not be able to pay off their loans. It was this sort of issue, especially in regard to mortgages, but also, to a lesser extent, with other types of loans, that played a key factor in launching the Great Recession of the late 2000s. This increased risk can, at least in theory, make it more difficult to get a traditional centralized finance loan. As a result, there is always the possibility that more and more people will, instead, turn to decentralized finance in order to take out a loan, thus, potentially, moving the world of cryptocurrency further and further into the mainstream.

That said, this theory may not be entirely accurate. This is because cryptocurrency does not exist in a bubble. Since there are some experts who believe that we are, as a whole, on the verge of another recession, and, since inflation is shooting up worldwide, people may be less willing to make speculative investments. Since cryptocurrency very much is a speculative investment, then it makes sense to assume that people will not want to invest in it as much, either because the cost of living has put a drain on their finances or because they are concerned about the future. With less activity, then it also follows that the crypto market will be down, as fewer people will be willing to buy crypto, thus causing prices to fall. It can be argued that we are seeing this happen already, with the likes of Bitcoin and Ether dropping to levels not seen in the previous 18 months or so.

Therefore, while there might be pressure on lenders in the centralized sphere, it does not mean that those issues will not come to bear on DeFi lenders, even if they might not do so immediately.

Why crypto loans?

We also should ask why might someone want to take out a loan in cryptocurrency in the first place? Well, it is possible that they might not have a good enough credit rating to get the amount of money they wanted to borrow. Secondly, they might be a serious crypto enthusiast who considers crypto to be a safer bet than fiat currency. Thirdly, they might consider the rate of interest to be more advantageous to them than a traditional loan. 

It is also worth noting that there are two different types of crypto loans, those with collateral and those without. Collateralised loans require someone to put up collateral, usually in the form of other cryptocurrency, to prove they can afford to pay the loan back. If, for whatever reason, they are unable to do so, they lose the collateral they provided. 

While loans with collateral are more common in the crypto sphere, there are some places that will allow you to take out a loan without having to provide something that can be taken away. Perhaps the two most notable providers of collateral-free crypto loans, which work much in the same way that a personal bank loan might do, with people being expected to pay back a certain amount every month over an agreed time period, are Goldfinch and Atlendis.  

There are, however, issues to point out with cryptocurrency loans. Firstly, cryptocurrencies can be volatile, so the real world, fiat currency, value of what you borrow might end up being lower than it was when you took the loan out. This is true for all crypto loans. Secondly, it is entirely possible that you might find yourself falling prey to a scam. You must be careful that you do not give out information that could leave you or your finances at risk, and you need to make sure that the crypto loan provider does not have a track record of deceiving customers. Thirdly, collateral free crypto loans can often have significantly higher rates of interest than regular crypto loans, so they could, ultimately, turn out to be very expensive in the long run. 

Final points

Anyway, that is all for now. We always say that you will need to do your own research, remember prices can go down as well as up, and that you should never invest more money than you can afford to lose when it comes to regular crypto investment. This is especially true when we are talking about taking a crypto loan. You will have to be sure that you can repay your loan under the terms given, and you have to be especially careful to look out for scams, especially when it comes to what we might refer to as pure DeFi crypto loans. While there is nothing wrong with taking out a crypto loan per se, you will need to be sure about it, and that will mean following the golden rules, remembering to do your own research, compare lenders and making absolutely sure that you will be able to repay it.

FAQs

DeFi is short for decentralized finance, the idea that financial services do not need banks or, indeed, a conventional structure behind whatever is offering them.

CeFi is short for centralized finance. This is linked with more traditional financial services although, confusingly, it can be used to refer to crypto platforms with a conventional structure and named staff and management.

One potential way of answering this question in a way which avoids repeating what we have just said is that centralized finance involves customers trusting people while decentralized finance involves people trusting the system. The names of the two different methods of finance should, ultimately, provide a clue. 

The answer to this depends on what you mean by CeFi. If you are talking about traditional, fiat, organizations, the top lending platforms are the major banks. If you are talking about crypto lending platforms with a more traditional structure, then some of the largest lenders include the Binance exchange, Compound and CoinLoan.

Further reading

The material provided on this website is for information purposes only and should not be regarded as investment research or investment advice. Any opinion that may be provided on this page is a subjective point of view of the author and does not constitute a recommendation by Currency Com Bel LLC or its partners. We do not make any endorsements or warranty on the accuracy or completeness of the information that is provided on this page. By relying on the information on this page, you acknowledge that you are acting knowingly and independently and that you accept all the risks involved.
iPhone Image
Trade the world’s top tokenised stocks, indices, commodities and currencies with the help of crypto or fiat
iMac Image
Trade the world’s top tokenised stocks, indices, commodities and currencies with the help of crypto or fiat
iMac Image