Decentralized finances have emerged in recent years and have revolutionized traditional finance systems. DeFi offers a new, alternative approach to traditional financial systems by integrating blockchain technology and smart contracts.
DeFi is defined by its use of blockchain technology that facilitates decentralized control and ownership.
Traditional finance refers to the financial system that has been in place for decades. These are your banks, running on government-issued currencies, and other financial institutions.
Today, we’ll be exploring the key differences between DeFi and traditional finance.
Accessibility and Inclusivity
The first key difference between DeFi and traditional finance systems is their approaches to accessibility and inclusivity.
DeFi systems pride themselves on being open to anyone with an internet connection. It’s built on open-source blockchain technology that makes it easily accessible worldwide. This means you don’t have to fill out a ton of documents and submit your personal information to access DeFi’s financial services.
Since DeFi also makes use of digital ledger technology, it’s easy to access financial services even in the most remote places. The only requirement is a solid internet connection.
On the other hand, accessing traditional financial systems is constrained by geographic location, credit score, and income.
Not just anyone can walk into a bank and get approved for a home loan, nor can they simply access the internet to open a banking account. Traditional finance systems operate according to government-set regulations and a ton of paperwork.
Control and Ownership
An appealing feature of DeFi systems is that users have direct control over their assets and finances. The blockchain technology that it runs on eliminates the need for intermediaries. This means that transactions take place directly between users via smart contracts.
This technology also makes it easier for crypto market makers to do their jobs quickly and effectively, according to gsr.io.
In contrast, traditional finance relies heavily on the work of intermediaries like brokers, banks, and payment processors. These intermediaries are responsible for facilitating transactions and enforcing regulations.
They also charge a fee for their services. A common fee is bank charges or interest rates.
Transparency and Trust
DeFi systems offer better transparency since all transactions and activities are recorded on the blockchain. Since the blockchain is accessible to all, anyone with an internet connection can look up the transactions.
DeFi protocols are also commonly open-source so their code is available to the public. This transparency promotes trust among users who can easily verify the system’s operation and view transactions.
With traditional finance, trust and transparency are hosted by a central authority or intermediary that ensures transactions take place correctly. Thus, transaction records and protocols are not accessible to the public.
However, since traditional finance runs on trusted, government-issued currencies like the dollar, people are willing to trust it due to its credibility.
Financial Products and Services
As mentioned, the crowning jewel of DeFi is its use of smart contracts, says IMF. Smart contracts have paved the way for the development of a ton of decentralized products that vary from lending, buying and selling, trading, and investments.
DeFi products also result in higher-yielding assets. For example, cryptocurrency trading and investment. We’ve all seen the value of Bitcoin soar and that’s all thanks to blockchain technology.
In contrast, traditional financial systems are limited by legacy systems, which result in slower product development. Banks offer loans, deposit insurance, the use of a bank account, various investment opportunities, and retirement plans.
However, their offerings are often limited.
Where traditional financial systems have a leg up is that they also offer professional advice. This is great for businesses or individuals who need financial guidance and are looking to grow their wealth.
Regulation and Compliance
Unlike traditional finance, DeFi allows its users to transact internationally without many rules or regulations. Users can easily transact as they want without fear of crossing any violations.
This is because DeFi is currently unregulated, which makes its future unpredictable. This means that you are running a higher financial risk because of unregulated activities, hackers, and potential vulnerabilities in the code.
On the other hand, traditional finance is highly regulated and operates according to various compliance frameworks. These frameworks protect consumers and investors and safeguard against fraud.
Risks and Security
Being that DeFi is a decentralized system and that their code is readily available online, they are vulnerable to hacking. Since there are no official regulations in place, this does place their users’ assets and funds at risk of being stolen.
With traditional finance, while there are some risks, their regulations, and operating frameworks largely defend against fraud. In addition, large financial institutions will also have entire departments dedicated to assessing financial risks, monitoring fraudulent activities, and safeguarding their client’s assets.
Centralization vs. Decentralization
DeFi is a decentralized system, meaning that there is no single point of control. No one has complete ownership of the blockchain. This is what allows anyone to access the system from anywhere in the world, regardless of their financial status or location.
Decentralization also gives users complete control over their assets.
In contrast, traditional financial systems are centralized with control lying in the hands of banks and financial institutions. Traditional financial institutions are also subject to government oversight to ensure that they are acting under the set rules and regulations.
This means that the client’s assets are held and, to a certain extent, controlled by intermediaries like banks, stockbrokers, and financial institutions.
Last Updated: August 30, 2023
