CeFi and DeFi, explained
Web3 comes with all kinds of acronyms, but really it's just lipstick on a pig. So in this issue, let's look at the top layer acronyms: CeFi and DeFi.
TL;DR: CeFi = There is a Central People Based Authority; DeFi = Technology is the direct replacement for people-based authority.
Hello Professionally Curious One!
This week I surpassed 275k views on LinkedIn for 2022. Last year it was 58k. I know it’s a vain metric, but I’m pretty stoked by it. I’ll talk soon about content creation and building an audience.
Today we’re talking about this other thing Web3 people keep talking about, which is DeFi. But to get to DeFi, we need to talk about CeFi. No we’re not talk about LoFi. And also, we are also not referring to SoFi.
Just CeFi and DeFi.
As always, you can find TL;DRs and graphics wherever possible!
May the Fourth be with you.
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WTF is CeFi?
WTF is DeFi?
TL;DR: CeFi or Centralized Finance/Traditional Finance is people trusting the business and its humans to execute specific operations as expected
Centralized Finance, Traditional Finance, ala Central Authority, is a model that describes traditional financial middleman institutions such as banks, credit unions, brokerage firms, and so forth.
A CeFi Model entails people trusting a business (or a collection of businesses) and it’s human operators and human-based systems to perform the business services.
Such services usually include:
Transactional Processing Services (Doing the number crunching & transfers)
Treasury Services (Holding my money)
Reporting (Telling me how much I earned / loss)
Example of a Transaction before considering Credit Card Companies, Payment Processors, and Remittance-Type Companies:
If you look at the above model, which is both a generalized conceptual model of a CeFi system, you’ll notice that at any given transaction there are at-least 5 different parties.
The sequence is this:
Payor
Payor’s Bank
Automated Clearing House ← Underpinned by the Clearing House Operator, or Central Authority
Payee’s Bank
Payee
There are around 100 Automated Clearing House systems globally, and you guessed it, its underpinned by a country’s central bank. Under this model, you are trusting the following parties to perform the following:
Payor’s Bank
To transmit my funds:
In the pre-digital age, quite literally sending money to someone was a pain in the ass since there used to be an element of physicallity to it, and thus, physical risk to your money can sometimes literally apply.To clerically maintain my account balances
Ensure completeness and accuracy of the data, and reporting of it in the form of bank statements
Central Authority
To settle, or dictate, the final account balances between banks
For 1 on 1 one-off transactions, you don’t need this level of rigor. However, the U.S. Automated Clearing House between the banks processed 29.1 Billion Transactions, or $72.6 Trilions of Dollars in 2021.
Payee’s Bank
To receive your funds:
To clerically maintain your account balances
Types of CeFi
While crypto, Coinbase is a CeFi.
Chase and Wells Fargo are CeFi. But not crypto.
TL;DR: Human-less financial processing - Decentralized Finance is people trusting the technology protocols to execute specific operations as expected
A DeFi model describes the absence of human-based businesses executing specific services, and instead has shifted the trust and reliance of execution to technology protocols.
Crude DeFi Representation
The above graphic represents a very simplistic explanation of DeFi in that there is an absence of middle-man humans and businesses between transactions. However, I do not find this representation because describing Technology as a Monolithic Answer is too crude of a representation.
Expanded DeFi Representation
Using this graphic, I can better explain to you what’s going on.
I make a payment to you using the blockchain.
The payment is processed by the blockchain network.
The record of the transaction is stored publically for me, or really anyone, to see provided that they have the context for it. Not to say it’s publically broadcasted, no, it’s more that it’s publically available to be accessed.
You receive the funds.
Expanding on step #2 - the blockchain network-
No Humans: The entire transaction happens in the absence of a human operator pressing and deciding on the purpose and business value of a transaction.
Crowdsourced Computer Procsesing: The transaction is validated repeatedly across the network by other users computers. The users are many, where as in a CeFi the users are few. The record is held publically across all network users.
Public Ledger - Quite literally everyone can see how the transaction moved and got settled.
The blockchain is sustained by its users who use it. Additionally, any feature changes to the code are contributed by developers, and agreed-upon by all a significant and undeniable majority on the network. Aka people have to vote and accept the change, in whichever way that blockchain’s consensus mechanism works.
I spent a few hours researching how someone actual votes in certain Blockchain and at this time, I haven’t found anything compelling beyond people pointing to voodoo magic (I jest). I’m curious to see what people click and do when it comes to voting.
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