What is DeFi and CeFi?

You’ve probably heard the term DeFi, but what is it? And what about another term, CeFi?

DeFi is short for Decentralized Finance, and CeFi then naturally becomes Centralized Finance. DeFi lives on the blockchain, as smart contracts that do something with cryptocurrencies, stablecoins, or other assets on the blockchain, in order to provide for decentralized exchanges, loan platforms, stablecoins and other financial services.

While CeFi typically include traditional financial services, those that operate without a shared blockchain/ledger, without smart contracts and the APIs defined by those smart contracts, more generally CeFi is everything that DeFi is not. CeFi can not exist as a concept without DeFi.

But how decentralized is DeFi? This is where viewing DeFi and CeFi as opposite ends on a broad spectrum makes the whole discussion more interesting. We can imagine smart contracts on Ethereum, where these contracts can’t be upgraded and contain no admin feature. There are not many such DeFi based systems, and if you include external dependencies, like a fiat price feed from an oracle, there are even less fully decentralized finance projects out there.

An opportunity to move further away from DeFi on the DeFi/CeFi scale can be viewed as a manifestation of increased third-party risk or counterparty risk. An example would be any stablecoin with off-chain assets, as these assets could be confiscated or mismanaged. It is then down to the operator to fully disclose their current holdings, and if their transparency framework is weakened they become less DeFi. If the assets are on-chain, you don’t need that trust element as you can verify instead.

Even if potential future regulatory frameworks would force stablecoin operators to follow better reporting frameworks, like those found within the money market fund industry, it does not make an operator of a stablecoin with assets off-chain any more DeFi, however.

So while it’s safe to say most projects are not 100% DeFi, very few, if any, with connections to a blockchain, are 100% CeFi. Stablecoins like USDC have a lot of CeFi, as they hold the underlying assets within the traditional financial systems. DAI is more DeFi because it is using on-chain cryptocurrencies as collateral, but it still has a dependencies on other CeFi assets in addition to price feeds. Also, if any DeFi system can be upgraded by someone, either with some admin key or through a DAO, there is always going to be a risk that they might move towards any of those extremes.

On the flip side, you might argue that some projects that lean more towards pure DeFi could expose you to higher technical risk, as they might be more complex and/or might not have anyone who can come and fix a bug. A CeFi stablecoin like USDC is a lot less technically complex than a more DeFi oriented stablecoin like DAI, as there’s a lot of machinery to maintain the peg on-chain. While this is true, it is not a requirement for being more DeFi. You can find examples of technically simple systems without any CeFi risk, for example the WETH contract. Technical complexity would therefore seem to be mostly orthogonal to the DeFi/CeFi scale.