Centralized and decentralized finance: Coexistence or convergence?

The financial crisis of 2007-08 revealed that centralized finance (CeFi) relying on large, interconnected financial institutions is easily destabilized. Since the crisis, significant regulatory tightening, monetary easing, and new competitors (e.g., fintechs) have created significant pressure on profit margins and CeFi business models. Recently, a new form of financial intermediation that functions independently of centralized intermediaries has emerged, namely decentralized finance (DeFi). DeFi relies on public, permissionless blockchains and uses so-called smart contracts to perform financial services such as borrowing, lending, and trading in a transparent and automated fashion. The paper gives an overview of DeFi and discusses its advantages and disadvantages compared to CeFi. We analyze different scenarios about the future paths of CeFi and DeFi, concluding that a convergence scenario is most likely.