Centralized vs decentralized technologies in banking and finances
The choice between centralization and decentralization remains one of the hottest topics in digital and traditional financial fields. Beside those two technologies lie such core concepts for finances and banking as funds and information security, end user technological comfort and customer freedom. All of those points are, of course, determined by the adaptivity of centralized and decentralized technologies to customer needs, privacy and user experience, no matter classical or disruptive the solution is.
Mass adoption of digital currencies as far as growing in popularity neobanks have proposed their users all around the globe a relatively new experience of financial transparency and economic inclusion with a higher level of own funds privacy and control. Even the oldest and biggest exchanges that are fully centralized are now turning towards the idea of decentralization. It is, of course related to the most popular field trends such as DeFi and decentralized digital wallets, as far as to the fact that last year over 4 billion US dollars were lost by centralized solution users.
There is a huge amount of financial digital storage, and they all differ from each other. Thus, there are two types of digital wallet solutions — centralized and decentralized ones. In their turn, centralized wallets are divided into two types: online (hot storage) and offline (cold storage). Historically, digital asset users and holders believe that cryptocurrency cold storage is safer, since digital coins are stored on the user’s own device having no access to the Internet. Yet, successful and unhackable (or barely unhackable) decentralized solutions have proven that key function decentralization makes the whole solution stronger and more trustable. So, what are those differences that finally make people go for either centralized or decentralized technology?
Centralized wallets provide services regulated by a third party. The keys to each user’s digital storage are located on a remote server. It turns out that all user keys are kept on the same server, which definitely makes them vulnerable and result in hacker attacks. However, centralized wallets provide less services and operations, so they are slightly more secure than exchanges. As for centralized exchanges, they basically use custodial solutions that make users deposit their funds during the trade actions on one controlled wallet that is the very heart of a centralized exchange mechanism.
Decentralized digital wallets offer direct access to the Blockchain network and its facilities without any third-party services. Thus, every user is himself or herself the only one responsible for all actions and information safety. As all keys and digital funds are located on each user’s device. The hacker attacks cannot, of course, be excluded but it becomes much more difficult to hack the server of a particular user of a decentralized storage than a well-known server of a centralized wallet or exchange. As after hacking a centralized storage server, the hacker immediately gains access to all wallets.
The Blockchain system was once concepted and created for a direct use without involving intermediaries such as centralized exchanges or wallets. This technology serves each and every customer financial needs by giving a full control over their funds and private information. That is one of the core reasons of contemporary neobanks running their solutions partly on the Blockchain technology basis. For the same reason, the Blockchain technology is being adopted by legaltech to optimize and clarify IP and other property deals, or by medtech and deeptech that want to clarify and optimize informational and communicational streams.
Yet, we should be admitting several options for the further development of digital centralized financial solutions. The reincarnation of a wallet to an exchange can be named as positive future development way. However, this scenario is costly and requires expansion of the services provided. This option is most likely because centralized wallets do not differ much from exchanges, except the scale of services and the lack of cards for withdrawals. Another development option consists in joining of centralized wallets to the existing centralized exchanges resulting in a shortage of funds for independent sites. However, these exchanges might not need those wallets to join them as they often have their own hot and cold storage. Even if the exchanges show interest in such mergers, centralized digital wallets will not increase their income from commissions.
At the same time, there are three mainly technological aspects that prevent and lower massive adoption of decentralization in a single moment. Apart from the fact that integrating new core technologies in any case takes a significant period of time and turns out to be quite expensive, the decentralized solutions are way much too complex in comparison with the centralized ones. Right after the decentralized technology implementation, every new service or feature integration will take longer time due to the decentralized system complexity.
The storage decentralization thus means users do not need to trust their funds to a single service with authority over deposits, withdrawals, storage and security of those funds. In the decentralized financial paradigm, any financial, banking and payment services do not stand out as targets for cyber-attacks giving birth to a better customer experience and new world financial structure.