DeFi Vs. CeFi Crypto Lending

Crypto lending has become a popular method for investors to increase their crypto portfolios and make extra income. Compared to traditional banks or TradFi, crypto lending offers a higher yield on crypto deposits. However, the rate differs according to platforms. Before crypto lending platforms became popular, investors had to leverage long-term holding or engage in short trading. Given the market’s volatility, both methods may be an unreliable way to earn extra income.

For instance, some investors typically buy crypto to HODL (a popular acronym for holding on to crypto through its price fluctuations). In a bear market like the 2024 market, it might take ages for an investor to make money HODLing. Refusing to sell with the belief that your crypto will rise is a decision that might bite you in the back. Short trading is more technical and might lead to more losses if you aren’t a proficient trader.

Crypto lending offers a better alternative to investors who want to earn profitably with minimal risks. It became one of the most vital use cases of decentralized finance after it was brought into the crypto world. Before now, services like lending were restricted to TradFi. As the crypto market grew, it was introduced alongside other banking services to the crypto world. The result was the emergence of DeFi and CeFi lending platforms.

The lending platforms offer lending and borrowing services to crypto users but differently. The difference in modus operandi has forced users into a debate about which is better. In every debate, a winner must emerge. This DeFi Vs. CeFi crypto lending guide will explain the differences, similarities, and benefits of these lending methods alongside the risks they pose.

What is DeFi lending?

DeFi (decentralized lending) is similar to TradFi, except that it uses the P2P model. It means that there is no central authority that governs how money is borrowed or lent. Lending and borrowing services are controlled by smart contracts. DeFi lending platforms allow anyone in any part of the globe to access financial services (borrow and lend crypto) without intermediaries. It is fast and instant and gives users more control over their money through their wallets.

In DeFi lending, crypto holders can earn passively on their holdings through the interest fees paid by the borrowers. It is a low-risk way of making more money in a volatile market like crypto. Also, it’s an attractive option if you don’t want to entrust sensitive details like your private keys to a third-party centralized service. In some lending platforms, lenders can withdraw their crypto-assets at any time, while others only allow you to make a withdrawal at the expiration of a period. Because of the absence of a central authority, transaction fees are drastically reduced.

Blockchain networks like Ethereum allowed businesses to build DApps that offered banking services to crypto users – that is how DeFi lending came about. Through smart contracts, users can deposit cryptos and earn interest on their investments. As explained, crypto lending protocols (DeFi precisely) offer a higher yield than regular banks. This high yield is one factor that led to the explosion of decentralized finance lending platforms.

What is CeFi Lending?

Centralized finance lending is the opposite of DeFi lending. All transactions and banking services are managed by a central authority. Because of the complexity of DeFi lending platforms, entrepreneurs decided to create platforms that would serve as a bridge between DeFi and traditional banking. These platforms will act as middlemen and broker deals between the lender and the borrower. This was how CeFi lending came about.

CeFi lending platforms like Celsius and BlockFi became popular due to their ease of use and simplicity. Inexperienced users or novices will easily use the platform without much intervention. In CeFi, only one account is required to start earning yield. These platforms would lend the money to the borrowers and then handle all the crypto transfers. Users only need to deposit to start earning income.

Differences

One of the differences between DeFi and CeFi lending is simplicity. In CeFi, users leave the management of their portfolios to the platform. However, this is different in DeFi. Users must be technically gifted to manage their funds and find their way around the platform.

Another major difference is user interaction. In DeFi lending, users will have to interact with smart contracts. They have to trust that it is secure and able to function as proposed. However, CeFi isn’t peer-to-peer – it is centralized and doesn’t require the amount of trust as interacting with a DeFi protocol. Users trust the people who manage funds and execute the services.

The application process is yet another key difference between these two. In CeFi, you have to deal with underwriting standards, which can be typically overbearing. DeFi lending doesn’t require so many underwriting standards.

Another significant difference lies in custody. Unlike CeFi, DeFi platforms allow users to control their assets. They are a non-custodial platform. As a custodian of your asset, no one has the right to move or destroy your assets without your authorization.

Similarities

CeFi lending and DeFi lending may have different settlement processes, but they are similar in some aspects. Besides the fact that they are lending protocols, DeFi and CeFi offer the following services – trading, staking, OTC trading, asset management, etc.

Risks

Lending crypto on DeFi and CeFi platforms comes with risks. The risks are higher in CeFi than in DeFi because of the custodial model employed. In the summer of 2024, Celsius froze customers’ funds, making it impossible for them to transfer, withdraw, or swap. A month after this, the platform filed for bankruptcy. The platform cited liquidity issues caused by the extreme bearish market conditions for suspending withdrawals.

Imagine being one of those whose assets were seized. That’s the risk we are talking about here. CeFi’s model exposes the various lending platforms to risks. Due to their lending standards, CeFi platforms are more prone to losing money. In DeFi, the reverse is the case. The sites do not have the same issue as centralized finance sites.

Another risk you might face is regulation. CeFi platforms are constantly checked by the U.S. SEC if they fail to register correctly with the regulator. BlockFi, for example, was penalized for failing to have the proper operating licenses. The platform agreed to pay a fine of $100 million. Due to the lack of proper operating licenses, the platform suspended yield to new customers. DeFi platforms aren’t regularly scrutinized.

Alternatives

For now, they aren’t better alternatives to CeFi and DeFi as far as lending is concerned. TradFi has long been the only option for people who want to make extra income, but the emergence of CeFi and DeFi have displaced TradFi as a better option for crypto investors. Therefore, they remain ideal for users who want to increase their portfolio.

Conclusion

Is there a clear winner in this DeFi vs CeFi lending guide? That depends on who is reading this guide. Investors are faced with having a high technical knowledge to use DeFi platforms or trust the people-based CeFi sites with their money. As explained, DeFi relies on open-source smart contracts, which makes it highly sustainable in bearish market conditions. The permissionless system ensures that DeFi platforms keep generating interest for crypto investors.

As an investor, you must comprehend the risks of DeFi or CeFi lending. Do you want to interact individually or trust a centralized authority? Given the risks, we can say that decentralized finance presents a better investment opportunity. It offers more transparency, and funds are more secure than centralized finance. Plus, they aren’t under any regulatory scrutiny like their CeFi counterparts.