You may have seen numerous articles about decentralized finance (DeFi) and its claims that it will radically change the traditional finance (TradFi) sector. DeFi supporters state that there is a core need for an open, transparent, and secure financial system, and that TradFi simply doesn’t provide that. Essentially, DeFi positions itself as an alternative to the banking system we currently have.
One of the arguments for DeFi is that because it is a blockchain-based concept, it is outside of governmental and regulatory control. This has a strong appeal to those who are concerned about what we have learnt about personal data collection by commercial entities and governments.
DeFi answers the desire for data security and privacy. It also “leverages a set of progressive, agile tools to give control to users,” according to Stably. It also offers features that traditional finance can’t provide, and this makes it an attractive alternative to the current system.
But what are the real differences between DeFi and TradFi? There are three key differences:
- In DeFi the public blockchain is the source of trust, whereas in TradFi it is regulatory bodies that are the source of trust.
- DeFi is gaining traction because it is open and transparent, and there are fewer barriers to accessing it. The opposite is true of TradFi, especially in terms of the barriers to access, which leaves billions of people unbanked worldwide.
- TradFi has its hands tied by regulatory forces, which makes it extremely difficult for its institutions to act with the same agility as DeFi projects.
DeFi’s use cases
There are also three strong use cases for DeFi.
1. Banking
Unlike TradFi, DeFi projects are able to offer banking without borders. TradFi struggles with this, and as mentioned before, this has left billions globally without a banking service. DeFi’s use of blockchain technology overcomes that issue and allows people in developing countries and rmote areas with access to banking via their mobile phone.
2. Circumventing oppressive governments
Oppressive governments are prone to issuing bans and restrictions on financial movement. TradFi can’t offer solutions, but again, because DeFi uses the blockchain and associated tools, it is able to circumvent government restrictions and provide uncensored global financial services.
- Creative finance
There is a level of creativity in DeFi projects in terms of developing new features and functions. In the past TradFi had a monopoly on financial products, but even those products associated with TradFi can be moved over onto the blockchain, giving DeFi another advantage.
Challenges to overcome
Naturally, while DeFi has advantages, it doesn’t have a clear home run. It also faces challenges. The biggest one is not hard to identify, and you don’t need to even ask an expert: it is getting the general public to trust the idea of unregulated open-source code. Cryptocurrency doesn’t yet have mass adoption and there is widespread mistrust of it, which bleeds over into the DeFi sector by association. There are fears about hacks amongst other things. Indeed, the DeFi tech is still in its infancy, with much work to be done to make it more trustworthy for a wider audience beyond DeFi fans.
Ultimately, DeFi has a way to go, but it undoubtedly has potential, and certainly as a way to give more people access to banking services. If its works hard on scalability, security and liquidity, it has a real opportunity to replace TradFi.