There are two philosophically different banking systems in the world today. Traditional Finance (TradFi), made up of major banks, credit unions, and national financial systems, and Decentralized Finance (DeFi), made up of decentralized exchanges, DApps, and other institutions that lack intermediaries. . Both systems are widely used and 5 million Individual DeFi accounts participating in the market estimated to be worth more than $50 billion. In the traditional financial world, 76% of people in the world have at least one bank account, but there are significant regional differences. In Japan, for example, that number is 98% for him.
DeFi still lags behind traditional finance, but it is gaining momentum every day. Recent events such as the Silicon Valley Bank collapse help explain why, and the impact is important for wealth managers to start planning for now.How DeFi Compares to TradFi Let’s break down the differences and what financial advisors should look out for to understand if it works and why DeFi could become a big part of a client’s portfolio.
DeFi Exists to Address the Biggest Problems Inherent in Traditional Finance
Bitcoin was founded in the aftermath of the 2008 financial crisis, detailed in the white paper By someone, or possibly a group of people, named Satoshi Nakamoto. The idea of a peer-to-peer electronic cash system that uses software code to authenticate and secure transactions without relying on centralized banks or government treasuries was revolutionary.
However, the Bitcoin ecosystem itself not designed Allow DeFi protocol. Bitcoin is a big part of the story, but the rise of DeFi can actually be traced back to his 2015 launch of Ethereum. The Ethereum system’s ability to process smart contracts is what makes truly decentralized apps and thus his DeFi possible. An ICO and his DeFi exchange followed. We now have many apps and operations that live on multiple chains. Some of them are long-established stores that handle large sums of money, while others are new Innovate existing ideas.
Of course, the use of DeFi did not cause TradFi’s death. Banking as it was known before 2008 continues today in much the same way, with some new regulations and significant changes. Traditional finance still has many of the same problems that occurred in 2008. For example, banks often charge high fees for simple activities, and these fees don’t always prevent more failures. The challenges facing banks today highlight this reality.
The failure of Silicon Valley Bank Second largest bank failure in American history And it marks the beginning of a series of problems in the banking sector. of Switzerland, Credit Suisse was acquired by UBS to prevent bankruptcy.according to new york times, the Banking Policy Institute sees the SVB’s collapse as “mainly a failure of management and supervision.” A reminder of why a healthy dose of skepticism is important is that SVB executives gave themselves hefty bonuses. Right before the bank went bankrupt.
Clearly, the traditional banking sector remains deeply flawed. However, DeFi shows that different operating systems can have financial systems based on different sets of values. In doing so, it offers a sharp criticism of TradFi.
Differences between DeFi and TradFi
Let’s take a look at the similarities and differences between DeFi and TradFi. TradFi is subject to far more regulation. This means many elements of DeFi are not possible, such as the possibility of complete anonymity. In traditional finance, networks were monitored by a central source of information. DeFi often allows for anonymity. Customers have their own money, often through DeFi networks, directly with whom they want to send money or trade.
They offer many of the same services, but many of the most common banking services are still relatively rare in DeFi. For example, her DeFi mortgage case for housing is hard to find. they exist.
DeFi apps and exchanges enable financial services to be offered in a way that is fundamentally different than the way TradFi institutions offer them. DeFi typically:
- Distributed: DeFi typically allows individuals to interact directly with each other. This is made possible by many systems, including peer-to-peer networks. This means that many services provided by DeFi, such as loans, transactions, and money transfers, are conducted between connected people without an intermediary. Shortened and reduced fees.
- Autonomously: DeFi enables a high degree of autonomy. Customers can keep their money, control which smart contracts they are interacting with, move assets around at any time, and check their favorite institution’s records at any time.
- trustless: As is the case with many blockchain systems, user autonomy combined with the immutability of records and the cardinal laws of smart contracts means a much lower level of trust is required. Compare this to traditional banks where users must believe their money is being invested wisely.
- transparent: As with many other applications based on blockchain technology, a record of all transactions is readily available. Decentralized institutions have different management styles, but many are relatively open.
When this works, individuals will have access to many financial services at a low cost at any given time, fully understanding that a combination of safety features and well-written code will prevent the theft and misuse of funds. can. Not all of the same services as TradFi are readily available for his DeFi, Manyit is not unreasonable for DeFi users to expect their DApp or DeFi exchange of choice to handle many of their financial needs.
Challenges Facing DeFi
Admittedly, DeFi has its shortcomings and faces several challenges that need to be addressed in order to gain mainstream adoption. One of the big hurdles is the complex user experience. DeFi platforms are often difficult to navigate and the terminology can be confusing for those unfamiliar with the area.
Although DeFi platforms are built on the principles of decentralization and transparency, they are still vulnerable to manipulation and exploitation by bad actors, as seen in the prevalence of fraudulent activities such as lag pulls and exit scams.Had some high profile Hacking and exploiting in the DeFi space. It has caused great loss to users. Additionally, the scalability limitations of the Ethereum blockchain, on which many of his DeFi platforms are built, can lead to network congestion and rising transaction fees as the number of DeFi users grows. This may impact costs associated with minting, exchange utilization and asset transfers, potential user deterrence, and the large amount of capital required for full participation.
DeFi Potential Over Traditional Finance
DeFi’s inherent value tends to lead to specific service options and applications for DeFi systems.
- Unauthorized – DeFi platforms operate on open protocols, so anyone with an internet connection can access and use the service. This eliminates the need for intermediaries and democratizes finance, allowing people around the world, especially those in unbanked or underbanked communities, to access financial services without the usual barriers. will be able to access
- Often anonymous (or nearly anonymous) – Many DeFi platforms offer users a high level of privacy. By leveraging encryption technology and a decentralized network, users can conduct transactions without revealing their personal information.
- Tend to have more flexible and efficient pricing structures – DeFi platforms are built on decentralized networks and do not rely on intermediaries, which greatly reduces the cost of maintaining and operating these services. DeFi platforms can offer more competitive rates and services compared to traditional financial institutions.
- Allowing individuals to interact directly with others in banking systems – Urb and compound It enables peer-to-peer lending and borrowing of digital assets without going through traditional credit checks or application processes, offering interest to lenders and streamlined loan access to borrowers.Decentralized exchanges such as Uniswap and sushi swap It facilitates direct asset trading, giving users more control and typically lower fees compared to centralized alternatives.
Additionally, while TradFi institutions tend to offer lower interest rates, even after a string of rate hikes by the Federal Reserve, DeFi protocols still offer a substantial yield advantage over TradFi institutions.Curve, Yearn , and prominent DeFi protocols such as AAVE show the potential of decentralized finance. Mainstream coins and stablecoins may not boast high yields, but certain new tokens offer remarkable returns that are virtually non-existent on TradFi.
Overall, traditional finance has been around for centuries and will never go away completely. But technology and culture have advanced in ways that open new doors for both consumers and their financial advisors. In the DeFi world, this will become increasingly fluent as it allows for more transparent and lower cost banking options, higher yields and greater protection from external factors such as rising interest rates and poor business decisions. It becomes a thing.
Yemu Xu is a serial entrepreneur, investor and early crypto adopter.He is a Coinbase-listed co-founder ARPA network binance listing vera protocoleven as ZX Squared Capitala crypto hedge fund focused on options strategies.