Mar
30
2023
CeFi vs DeFi: Similarities and Differences Compared

CeFi vs DeFi: Similarities and Differences Compared

By | Growing Wealth, invest, Investing | Comments Off on CeFi vs DeFi: Similarities and Differences Compared

CeFi and DeFi are two terms that have become increasingly popular in the world of finance and cryptocurrency. CeFi, or Centralized Finance, refers to crypto and blockchain companies that operate like traditional financial systems, meaning a private central authority controls them and users are customers. DeFi, or Decentralized Finance, on the other hand, is a new type of financial system that operates on a blockchain network. Unlike CeFi, DeFi products and services are not controlled by a private central authority but are managed by an open-source network of computers.

While CeFi and DeFi may sound similar and have similar functions, there are some critical differences between the two. Investors should know this before investing in cryptocurrencies or blockchain technology.

DeFi vs CeFi: Similarities

Decentralized finance (DeFi) and centralized finance (CeFi) are more known for the distinction between the two financial systems. Nonetheless, DeFi and CeFi have several things in common:

Financial Services

As their names suggest, DeFi and CeFi platforms allow users to access financial services such as lending, payments, and trading securities exchanges. They also both use digital assets as collateral for these services.

Also, a large number of people around the world can access DeFi and CeFi products, making it easy for individuals and businesses to access financial services regardless of their location.

Recommended: Centralized vs. Decentralized Exchanges: Six Differences to Consider

Use of Technology

Another similarity is that both DeFi and CeFi platforms use digital and internet-based technologies to provide financial services. DeFi platforms are built on blockchain technology, while CeFi platforms use traditional technologies such as databases and servers to provide their services, in addition to some use of blockchain technology. These technologies allow both algorithms and automated processes to facilitate financial transactions and provide financial services, making it easier and more efficient to conduct financial transactions.

DeFi vs CeFi: Differences

As noted above, DeFi and CeFi are more known for their differences than similarities. Some of these differences include the following:

Centralization

DeFi is decentralized, meaning that a single entity, such as a bank or government, does not control it. Instead, it often relies on decentralized autonomous organizations (DAOs), open source networks, and decentralized ledgers, such as a blockchain, to facilitate financial transactions and provide financial services. CeFi, on the other hand, is centralized, meaning that a single private entity, such as a bank or financial institution, controls it.

Asset Custody

Asset custody refers to the process of securely holding and managing digital assets, such as cryptocurrencies, on behalf of users. Asset custody is a critical component of DeFi, as it ensures the security and integrity of users’ assets and helps prevent theft and fraud. In DeFi, users generally manage their digital assets directly, using a crypto wallet or other secure storage solution. In contrast, CeFi platforms generally act as a user’s asset custodian, meaning they control the assets.

Smart Contracts

DeFi relies on smart contracts, self-executing contracts with the terms of the agreement between buyer and seller directly written into lines of code. Smart contracts enable DeFi transactions to be transparent, secure, and automated. CeFi does not use smart contracts and instead relies on traditional contracts and intermediaries to facilitate financial transactions.

Transparency

Some experts consider DeFi more transparent than CeFi, as it relies on public decentralized networks and blockchain technology; users and researchers can track transactions in case of issues. CeFi, on the other hand, is vulnerable to centralized points of failure, such as hacks and data breaches.

Innovation

DeFi is often considered more innovative and experimental than CeFi, as it is a newer and less established financial system constantly evolving and exploring new technologies and approaches. CeFi, on the other hand, is a more established and traditional financial system that tends to be more conservative and risk-averse.

Customer Service

CeFi companies usually have robust customer support staff to assist users when they encounter issues. This customer service gives users a sense of security. In contrast, there are fewer customer support services with DeFi platforms, which may be an issue if problems arise when using the products.

Regulations

CeFi companies are subject to laws and regulations by government agencies and financial authorities, which aim to ensure the integrity and stability of the financial system. Some regulations include Know Your Customer (KYC) and anti-money laundering rules. In contrast, DeFi platforms operate in a regulatory gray zone.

Pros and Cons of DeFi

Pros

 Cons
Users control their own assets Lack of regulatory oversight
May be resistant to sudden changes Potential for technical issues

DeFi has both pros and cons. Some of the main advantages of DeFi include greater accessibility and control for users. Because DeFi platforms are built on blockchain technology and operate without the need for a central authority, they offer users greater control over their assets. Additionally, the open source and decentralized nature of the blockchain may make DeFi platforms, like decentralized exchanges (DEX), resistant to sudden changes because users can observe and verify operations.

However, DeFi also has some disadvantages. One of the main disadvantages is the lack of regulatory oversight. Because DeFi platforms operate without the need for a central authority, they are not subject to the same level of regulatory oversight as traditional financial institutions. This can make it difficult for users to know if they are using a trustworthy DeFi platform and they can be susceptible to fraud and scams.

Another disadvantage is the potential for technical issues. Because DeFi platforms are built on complex technology such as smart contracts and blockchain, there is a risk of technical issues arising that could affect the platform’s functionality. Relatedly, DeFi usually has difficult user experience which prevents non-tech savvy users access to the platforms.

Pros and Cons of CeFi

Pros

 Cons
Stability and security Users lack control of their own assets
Many financial services Potential for censorship

Some of the main advantages of CeFi include stability and security. Because CeFi platforms are controlled by a central authority, they are subject to regulatory oversight and may be more stable and secure than decentralized platforms. This can provide users with a greater sense of trust and confidence in the platform.

Another advantage of CeFi is the ability to access a broader range of financial services. Because CeFi platforms are typically operated by institutions with ties to traditional finance, they can offer a wider range of services, such as loans, credit cards, and investment products. Additionally, CeFi companies can offer seamless conversion of digital assets to fiat currency and vice versa. This can provide users with more options and flexibility.

However, CeFi also has some disadvantages. One of the main disadvantages is the lack of control for users. Because CeFi platforms are controlled by a central authority, users are subject to the policies and regulations of that authority. This can limit users’ ability to access and control their own assets.

Another disadvantage is the potential for censorship. Because CeFi platforms are controlled by a central authority, there is a risk that the authority could censor certain transactions or activities on the platform. This could limit users’ freedom and ability to access certain services.

Can CeFi and DeFi Work Together?

Many analysts believe it is possible for CeFi and DeFi to work together. While the two types of platforms have some differences, they also have some similarities and can potentially complement each other.

One way that CeFi and DeFi could work together is by combining the strengths of both types of platforms. For example, DeFi could provide the accessibility and control that users desire, while CeFi could provide the stability and security of traditional financial institutions. This could allow for a more balanced and comprehensive approach to finance.

Another way that CeFi and DeFi could work together is through the use of interoperability. Interoperability refers to the ability of different systems or platforms to work together and exchange data. By using interoperability, CeFi and DeFi platforms could share information and services, allowing users to access a wider range of financial services.

The Takeaway

CeFi and DeFi offer unique opportunities for investors and users to access financial services and products. CeFi is typically more regulated and centralized, while DeFi is more decentralized and operates outside of traditional financial systems. Both have their advantages and disadvantages, and it is up to the individual investor or users to decide which platform best fits their needs and goals. Ultimately, the choice between CeFi and DeFi will depend on an individual’s risk tolerance, preference for regulation, and desire for decentralization.

FAQ

How does DeFi differ from centralized finance?

DeFi differs from centralized finance in several key ways. The main difference is that DeFi platforms operate without a central authority, whereas centralized finance relies on traditional financial institutions controlled by a central authority. This lack of a central authority in DeFi means that users theoretically have complete control over their assets and are not subject to the policies and regulations of a central authority. In contrast, centralized finance is subject to the policies and regulations of the institutions and governments that control and oversee it.

How are crypto and DeFi different?

Cryptocurrency and DeFi are two related but distinct concepts in finance. Cryptocurrency is a digital asset that uses cryptography for security and operates on a decentralized ledger called the blockchain. DeFi, on the other hand, refers to the use of blockchain technology to provide financial services such as lending, borrowing, and trading without the need for a central authority.

Is all crypto based on decentralized finance?

Not all cryptocurrency is based on decentralized finance. While DeFi is a growing movement in cryptocurrency, not all cryptocurrencies are designed specifically for use in DeFi, like lending or asset trading.

Photo credit: iStock/Delmaine Donson

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Mar
30
2023
How to Use the Fear and Greed Index To Your Advantage

Guide to the Fear and Greed Index

By | Growing Wealth, invest, Investing | Comments Off on Guide to the Fear and Greed Index

What Is the Fear and Greed Index?

The Fear and Greed Index is a tool developed by CNN (yes, the news network) to help gauge what factors are driving the stock market at a given time.

If you’ve ever taken a look at how the market is doing on a given day and wondered just what the heck is going on, the Fear and Greed Index may be helpful in deciphering the overall mood of the markets, and what’s behind it.

CNN’s Fear and Greed Index attempts to track the overriding emotions driving the stock market at any given time — a dynamic that typically toggles between fear and greed.

The Index is based on the premise that fear and greed are the two primary emotional states that influence investment behavior, with investors selling shares of stocks when they’re scared (fear), or buying them when they sense the potential for profit (greed).

CNN explains the Index as a tool to measure market movements and determine whether stocks are priced fairly or accurately, with the logic that fear drives prices down, and greed drives them up, or is used as a signal of when to sell stocks.

There are specific technical indicators used to calculate the Fear and Greed Index (FGI), and strategies that investors can use to inform their investment decisions based on the Index.

Understanding the Fear and Greed Index

The Fear and Greed Index uses a scale of 0 to 100. The higher the reading, the greedier investors are, with 50 signaling that investors are neutral. In other words, 100 signifies maximum greediness, and 0 signifies maximum fear.

To give some historical context, on Sept. 17, 2008, during the height of the financial crisis, the Fear and Greed Index logged a low of 12. On March 12, 2020, as the pandemic recession set in, the FGI hit a low of 2 that year.

Seven different types of stock indicators are used to calculate the Fear and Greed Index.

CNN tracks how much each indicator has veered from its average versus how much it normally veers. Then each indicator is given equal weighting when it comes to the final reading. Here are the seven inputs.

1.    Market Momentum: The S&P 500 versus its 125-day moving average. Looking at this equity benchmark relative to its own history can measure how the index’s 500 companies are being valued.

2.    Stock Price Strength: The number of stocks hitting 52-week highs and lows on the New York Stock Exchange, the largest of the world’s many stock exchanges. Share prices of public companies can signal whether they’re getting overvalued or undervalued.

3.    Stock Price Breadth: The volume of shares trading in stocks on the rise versus those declining. Market breadth can be used to gauge how widespread bullish or bearish sentiment is.

4.    Put and Call Options: The ratio of bullish call options trades versus bearish put options trades. Options give investors the right but not the obligation to buy or sell an asset. Therefore, more trades of calls over puts could indicate investors are feeling optimistic about snapping up shares in the future.

5.    Junk Bond Demand: The spread between yields on investment-grade bonds and junk bonds or high-yield bonds. Bond prices move in the opposite direction of yields. So when yields of higher-quality investment-grade bonds are climbing relative to yields on junkier debt, investors are seeking riskier assets.

6.    Market Volatility: The Cboe Volatility Index, also known as VIX, is designed to track investor expectations for volatility 30 days out. Rising expectations for stock market turbulence could be an indicator of fear.

7.    Safe Haven Demand: The difference in returns from stocks versus Treasuries. How much investors are favoring riskier markets like equities versus relatively safe investments or assets, like U.S. government bonds, can indicate sentiment.

The Fear and Greed Index page on the CNN website breaks down how each indicator is faring at any given time. For instance, whether each measure is showing Extreme Fear, Fear, Neutral, Greed, or Extreme Greed among investors.

“Stock Price Strength” might be showing Extreme Greed even as “Safe Haven Demand” is signaling Extreme Fear.

Tracking the Fear and Greed Index Over Time

The Fear and Greed Index is updated often — CNN says that each component, and the overall Index, are recalculated as soon as new data becomes available and can be implemented.

Looking back over the past several years, the Index has tracked market sentiment with at least some degree of accuracy. For example, prior to the COVID-19 pandemic, the market was seeing a bull run and hitting record levels — the Index, in late 2017, was nearing 100, a signifier that the market was driven by greed at that time.

Conversely, the Index dipped into “fear” territory (below 20) during the fall of 2016, when uncertainty was on the rise due to the U.S. presidential election at that time. Note, too, that midterm elections can also affect market performance.

How Does the Fear and Greed Index Fare Against History?

As mentioned, the Index does appear to capture investor sentiment with some degree of accuracy. The past few years — which have been rife with uncertainty due to the pandemic — showed pockets of fear. For example, the Index showed “extreme fear” among investors in early 2020. That was right when the pandemic hit U.S. shores, and absolutely devastated the markets.

However, over the course of 2020, and near the end of the year, the Index was scoring at around 90, as the Federal Reserve stepped in and large-scale stimulus programs were implemented to prop up the economy.

Interestingly, the Index then dipped down into the “fear” realm in late 2020, likely due to uncertainty surrounding the outcome of the U.S. presidential election. It likewise saw a fast swing toward “greed” in the subsequent aftermath.

Again, these largely mirror what was happening in the markets at large, and economic sentiment.

How Does the Fear and Greed Index Fare Against Other Indicators?

While the Fear and Greed Index does fold several indicators into its overall calculations, it is more of an emotional barometer than anything. While many financial professionals would likely urge investors to set their emotions aside when making investing decisions, it isn’t always easy — and as such, investors can be unpredictable.

That unpredictability can have an effect on the markets as investors may panic and engage in sell-offs, or conversely start buying stocks and other investments. Ultimately, it’s really hard to predict what people and institutions are going to do, barring some obvious motivating factor.

With that in mind, there are other market sentiment indicators out there, including the American Association of Individual Investors (AAII) Sentiment Survey, the Commitment of Traders report published by the CFTC (one of several agencies governing financial institutions), and even the U.S. Dollar Index (DXY), which can be used to measure safe haven demand. They’re all a bit different, but attempt to capture more or less the same thing, often with similar results.

For instance, while the Fear and Greed Index showed a state of fear in mid-March, the AAII Sentiment Survey likewise showed a majority of investors with a “bearish” sentiment as well during the same time frame.

And, of course, there are a number of other economic indicators that you can use to inform your investing decisions, such as GDP readings, unemployment figures, etc.

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Dos and Don’ts of Using the Fear and Greed Index

Why is the Fear and Greed Index useful? The same reason that any sort of measurement or gauge has value. In this case, measuring sentiment can help you determine which move you want to make next as an investor, and help you ride investing trends to potentially bigger returns.

Are you being too greedy? Too fearful? Is now the time to think about herd mentality?

Also generally, some investors often try to be contrarian, so when markets appear frothy and the rest of the herd appears to be overvaluing assets, investors try to sell, and vice versa.

💡 Recommended: Should I Pull My Money Out of the Stock Market?

Dos

Use the Index to realize that investing can be emotional, but it shouldn’t be.

You can also use it to determine when to enter the market. Let’s say, for instance, you’ve been monitoring a stock that becomes further undervalued as investor fear rises, that could be a good time to buy the stock.

Don’ts

Don’t only rely on the Fear and Greed Index or other investor sentiment measures as the sole factor in making investment decisions. Fundamentals — like how much the economy is growing, or how quickly companies in your portfolio are growing revenue and earnings (which will be apparent during earnings season) — are important.

For instance, the FGI may be signaling extreme greed at some point, with all seven metrics indicating a rising market. However, this extreme bullishness may be warranted if the economy is firing on all cylinders, allowing companies to hire and consumers to buy up goods.

💡 Recommended: Using Fundamental Analysis on Stocks

What Is the Crypto Fear and Greed Index?

While CNN publishes and maintains the traditional Fear and Greed Index, there are other websites that publish a similar index for the cryptocurrency markets.

The Crypto Fear and Greed Index operates in much the same way as CNN’s Index, but instead, focuses on sentiment within the crypto markets. The Crypto Fear and Greed Index is published and maintained by Alternative.me.

The Takeaway

The Fear and Greed Index is one of many gauges that tracks investor sentiment, and CNN’s Index focuses on seven specific indicators to measure whether the market is feeling “greedy” or “fearful.” While it’s only one indicator, in recent years, it has served as a somewhat accurate barometer of the markets, particularly regarding major events like elections and the pandemic.

But, as with anything, investors shouldn’t rely solely on the Fear and Greed Index to make decisions, though it can be used as one of many tools at their disposal. As always, it’s best to check with a financial professional if you have questions.

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FAQ

Is the Fear and Greed Index a good indicator?

It can be a “good” indicator in the sense that it can be helpful when used in conjunction with other indicators to make investing decisions. That said, it shouldn’t be the only indicator investors use, and isn’t necessarily going to be accurate in helping determine what the market will do next.

Where can you find the Fear and Greed Index?

The Fear and Greed Index is published and maintained by CNN, and can be found on CNN’s website.

When does it make sense to buy, based on the Fear and Greed Index?

While you shouldn’t make investing decisions solely based on the Fear and Greed Index’s readings, generally speaking, the market is bullish when the Index produces a higher number (greed), and is bearish when numbers are lower (fear).

Photo credit: iStock/guvendemir

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
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Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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