TradFi: What does it mean?
Traditional Finance (TradFi) refers to the traditional financial system that has been in existence for decades. It is a framework where all the funds that customers provide are managed by a single, central authority. These involve insurance companies, banks, the stock market, and other regulated financial entities.
In the world of cryptocurrency, TradFi is usually utilized to distinguish traditional financial systems from decentralized finance platforms, which are based on blockchain technology and operate independently of centralized authorities. However, in TradFi, financial systems function as centralized intermediaries that facilitate the movement of cash and charge customers commission fees for their services.
In TradFi, consumers do not have complete control over their money as they must place trust in the financial system. These systems are subject to strict regulation by public governance, laws, licenses, and financial authorities. Additionally, transactions in TradFi are mutable, meaning that if a consumer fails to meet certain requirements, transactions can be reversed.
Are there any limitations of TradFi?
- Less transparent: A centralized entity has greater authority and influence over the data flow, thereby lowering the awareness of other components of the system regarding internal proceedings within the organization.
- Prone to corruption: People in the power of authority may prioritize their own interests over ensuring equitable distribution of financial services among all system members.
- Less democracy: Traditional finance usually is biased towards larger institutions and organizations, granting them greater privileges compared to other participants in the financial market, such as less favored small and medium enterprises (SMEs) or startups.
DeFi: What does it mean?
Decentralized Finance (DeFi) defines the emerging financial technologies based on secure distributed ledgers similar to those utilized by cryptocurrencies. It’s a distinct approach from the traditional models of finance for centralized finance or fiat currency within the cryptocurrency markets.
With DeFi, there is no centralized authority. However, authority is distributed in the decentralized approach that is despite providing more power and control to individuals. It eliminates the fees that banks and other financial companies charge for utilizing their services. Individuals can store their money in a reliable digital wallet, and swiftly transfer funds, and anyone with internet access can make use of decentralized finance (DeFi).
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Benefits and limitations of DeFi
- Permissionless: Compliance with KYC regulations is not required as financial services are accessed through a digital wallet.
- P2P asset swap: Asset exchanges occur without intermediaries, as organizations or individuals can engage in direct trading without incurring any commissions.
- More transparency and democracy: DeFi provides access to an extensive range of financial services without the need for third-party oversight or a centralized authority.
- Highly volatile and risky: The absence of insurance evenly distributes risks among participants, meaning that in the event of fraud, all users of the blockchain may bear the losses.
- Scalability: Transactions conducted through blockchain experience require a longer completion time. Blockchain technology is still unable to process a sufficient number of transactions per second to surpass the efficiency of traditional centralized finance.
- Low interoperability: Every blockchain possesses its own ecosystem and applications. However, the interoperability between different blockchains is not yet seamless enough.
- Cost-demanding: The majority of DeFi products provide financial services with higher commissions or fees compared to those offered by traditional finance companies.
Services offered by DeFi
- DeFi Development Services: The DeFi development services provide businesses with secure, fast, and cost-effective financial transactions on the blockchain. These services encompass uncomplicated management of DeFi assets, trustworthy and transparent fundraising, and a range of other benefits. Additionally, they encompass the entire process of designing, developing, integrating, supporting, and advancing diverse DeFi solutions.
- DeFi dApps Development: DeFi dApps refers to software programs that communicate with blockchain and execute with a decentralized network. It includes various services, such as dApp consultation, designing, smart contract development, maintenance, and support, etc.
- DeFi Exchange Development: DeFi exchange (DEX) development services provide a peer-to-peer (P2P) marketplace that directly links buyers and sellers of cryptocurrencies, eliminating the need for intermediaries or third parties.
- DeFi Wallet Development: A DeFi wallet development service provides a type of non-custodial wallet designed to securely store digital assets such as cryptocurrencies and NFTs. These wallets empower users by providing them with complete control over their digital assets through access to their private keys.
- DeFi Token Development: A DeFi token refers to a cryptocurrency model that provides a strong basis for launching diverse businesses rapidly and effectively, as they operate on a fully decentralized framework.
- DeFi Smart Contract Development: Smart contracts adhere to a digital agreement or protocol where each party defines a set of predetermined conditions or rules that must be met in order for the transaction to be executed automatically. DeFi smart contract development services help in eliminating the necessity of costly intermediaries for transaction processing and exchanges, while simultaneously ensuring transparency and visibility on the blockchain network.
The key difference between TradFi and DeFi
- Centralization: The decentralized and trustless nature of DeFi services is achieved through the utilization of blockchain technology and the integration of smart contracts. DeFi replaces the intermediary with smart contracts, and users trust the public blockchain to deliver the services promised. Unlike DeFi, Traditional Finance (TradFi) relies on centralization, relying on governing bodies and regulators to establish a trustworthy system. This approach to finance comes with the disadvantages of overhand regulation and financial exclusion that might hinder innovation.
- Accessibility: The heavy-handed restrictions linked with TradFi have made it inaccessible to several users, now called the “unbanked” population. The high barrier to entry limits the number of people that could partake in traditional finance services. DeFi stands out for its transparency and openness, free from the entry barriers often encountered in TradFi due to the absence of centralized entities overseeing it. The expansive capabilities of this technology foster financial inclusion, allowing anyone to participate in the system.
- Regulation: TradFi systems are heavily regulated using distinct needs necessary for participation. In Traditional Finance (TradFi), centralized governing bodies often require users to obtain authorization from regulators, possess official licenses, and undergo Know Your Customer (KYC) or Anti-Money Laundering (AML) procedures.
DeFi doesn’t rely on the central regulatory body to ensure asset exchange and trading. Hence, transactions are seamless and hassle-free. The DeFi platform provides traders control over their assets and wallets.
How to bridge the gap between TradFi and DeFi?
The finance industry’s infrastructure is complex and composed of multiple layers. On the one hand, the traditional banking system has several limitations, as it fails to offer equitable opportunities for individuals, SMEs, and startups to access quality services. On the other hand, decentralized finance (DeFi) is still in its early stage of development and lacks a well-defined jurisdiction for governing decentralized finance and digital assets.
Nowadays, it is possible to get financial services in both ways. For example, a company can borrow funds via a P2P lending platform or through a crypto-decentralized lending platform. Here, the process of lending funds will be distinct with its respective advantages and disadvantages. This signifies how diverse the finance market has become with a wide range of financial solutions.
TradFi and DeFi can provide the same financial services in different ways, as shown in the following table:
|Traditional payment platforms, such as PayPal, Google Pay, Cash App, etc.
|DeFi stablecoins (DAI), such as AAVE, Curve Finance, etc.
|Broker-dealer active in securities and repo lending.
|Crypto decentralized lending platforms, such as Compound and Aave.
|Crypto decentralized platforms, such as Convex and Yearn.
Which one is better: TradFi vs DeFi?
Traditional finance is an excellent and well-organized system. Currently, it facilitates a large part of the world’s population. Yet, people’s choice is changing fast. People are searching for a way to control and manage their finance better. Today, decentralized finance is the most efficient alternative to traditional finance.
Decentralized finance enables users to transact privately, securely, and efficiently. Hence, if the user is looking for a system that enables them to transact anonymously, then DeFi is a great option.
Closing thoughts: What does the future behold?
With the advancement DeFi brings, it can be concluded that DeFi might replace TradFi systems in the future. For this to occur, DeFi-related issues, such as liquidity, scalability, lack of regulation, and security should be resolved before its services can go mainstream.
However, while TradFi and DeFi are fundamentally different, current trends define that these two systems can operate together. Traditional banks started to recognize the potential of DeFi. Few are working on crypto-based services for clients, while others are developing integrations that enable users to utilize DeFi protocols within TradFi applications.
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