CeFi

The bitcoin space is, and its financial on-ramps and off-ramps are still very much in the developmental phase. To help close the gap between traditional economic systems like the banks and the bitcoin blockchain. We’ve seen these new centralised companies spring up to provide a stop-gap solution. 

These centralised platforms are custodial services that act as the broker or middle-man between legacy finance and you, the bitcoiner. 

Since all transactions are conducted by an entity that is regulated or is subject to regulation, it is a centralised business. That’s where the term centralised finance comes from, the idea that the service they provide is tied to the company itself and not a smart contract platform.

Centralised financial platforms establish relationships with banks in different countries. They provide the infrastructure for banking services while taking on the risk of holding bitcoin on your behalf. A risk that many traditional banks aren’t willing to do at this point. 

CeFi creates the potential for earning yield via bitcoin-based accounts that are functionally similar to a traditional bank’s savings accounts — but may offer substantially higher returns. Unlike conventional savings accounts, bitcoin deposits aren’t currently eligible for government-backed or insurance, so you should make sure to understand the risks involved. Some platforms, however, does offer a principal guarantee on deposits up to a point, but you will need to consult each platform’s terms and conditions.

Where does the yield come from?

Some or all of your bitcoin holdings are put to work and lent out to others. These borrowers pay the centralised provider an interest rate for borrowing, and that provider passes on some of the interest to you. Your bitcoin may be used as liquidity to cover “buy and sell orders” on the platform, or your bitcoin is borrowed to exchanges to provide traders with leverage or to trading houses that may require capital to complete a certain short term trade. 

How does CeFi borrowing connect to CeFi saving?

CeFi platforms act as the middle man and take on the liabilities of all parties involved to facilitate the borrowing of money against your bitcoin holdings or lending out your bitcoin holdings. The model works the same way you’d use traditional assets as collateral to apply for a bank loan. 

Some users will enter into contracts to borrow against their bitcoin and pay the loan back with interest. Then on the flip side, the interest users pay for borrowing money is where the yield you can earn for holding bitcoin via CeFi platforms. It’s up to the CeFI platform to strike a balance where there are enough loans issued with interest to cover their operating costs and pay their obligations. 

Unlike bank loans, CeFi interest accounts or loans typically require little or no paperwork. Depending on the platform and the country, these platforms will allow you to use bitcoin to borrow up to 50% of its market value without a credit check. 

If you do choose to use any of these platforms, please take note that in most cases, you will have to comply with KYC and AML laws, giving up your identity to these platforms. The data you provide may also be accessed by third parties that these platforms work with and taints the coins (UTXOs) moving in and out of this account as they are tied to your identity. 

Additionally, when you use a CEFI platform, you have to give up ownership of your coins to access any of their products. They hold the bitcoin you send them on your behalf, and you receive a bitcoin IOU as you would with a bank. You may see a balance on the screen when logging into your account, but in theory, that is only a promise to pay once you withdraw your funds. 

You are taking on third-party risk, such as:

1. Their ability to correctly custody coins, that they manage their reserves properly
2. That they have the liquidity to pay you out
3. That their security practices are up to the task, so they are not hacked.
4. The chance they won’t up and disappear
5. That they won’t be taken over by a government and have funds seized.

In cases such as these, you may not have much say in getting your funds back, and it’s a risk you have to consider before committing to any of their products.