DeFi vs CeFi
Centralized finance (CeFi) refers to the traditional financial system which relies on interconnected financial institutions. Recently, a new form of financial intermediation that functions independently of centralized intermediaries has emerged, namely decentralized finance (DeFi). DeFi relies on public, blockchains and uses so-called smart contracts to perform financial services such as borrowing, lending, and trading in a transparent and automated fashion.
In this paper Wieandt and Heppding look at the advantages and disadvantages of DeFi:
- The main technical advantages resulting from the underlying blockchain technology include high transparency, trustlessness, and immutability.
- From an economic perspective, the main risks and disadvantages of DeFi compared to CeFi relate to oracle dependency (information on exchange rates is provided by third parties), the design of stablecoins, high levels of leverage, impermanent losses in liquidity pools, regulatory uncertainty, and potentially high barriers to entry for less affluent users engaging in lower-value transactions.
- DeFi is characterized by technical limitations of the underlying blockchain technology, which affect the scaling and further expansion of DeFi.
We consider it more likely that DeFi and CeFi will ultimately co-exist separately, with minimal linkages between the two sectors, such as dedicated off-ramp service providers facilitating exchange between fiat currency and cryptocurrencies, which would be used to access and interact with DeFi protocols. To minimize the risks of contagion from cryptocurrency price volatility and operational and money-laundering risks, CeFi would minimize its direct involvement in DeFi. This is, for the most part, the status quo scenario. The scenario we consider most likely, however, is that DeFi and CeFi will ultimately converge to leverage synergies and mutual benefits.
Centralized and decentralized finance: Coexistence or convergence?
Authors: Axel Wieandt, Laurenz Heppding
From: WHU – Otto Beisheim School of Management, Technical University of Darmstadt
Will decentralized exchanges overtake centralized ones in the future?
In this paper, Barbon and Ranaldo, asses market quality of centralized cryptocurrency exchanges (CEXs) and decentralized exchanges (DEXs), focusing on market liquidity and price efficiency. They look at market liquidity by computing effective transaction costs, which include settlement fees as well as gas fees, for each. They find:
- Exchange and gas fees weigh relatively heavily on DEX’s total transaction costs.
- After accounting for transaction costs, no-arbitrage conditions are less restrictive for DEXs and result in larger realized deviations from the theoretically efficient price.
They finally propose a stylized model of DEX liquidity provision, linking trading volume, exchange fees, and liquidity in equilibrium. Their theory identifies the quantitative conditions for DEXs to overtake CEXs in the future.
On The Quality Of Cryptocurrency Markets: Centralized Versus Decentralized Exchanges
Authors: Andrea Barbon, Angelo Ranaldo
From: University of St. Gallen
