TradFi vs DeFi: Differences and Similarities
Published March 27, 2022.
Decentralized finance (DeFi) is an umbrella term used to describe financial services based on blockchain technology that seeks to provide users with open, fair, and transparent financial services while eliminating intermediaries. DeFi removes the control that centralized institutions like banks and governments have over finance services. These entities usually complicate transactions, leaving users with little control over their funds.
TradFi, or traditional finance, refers to mainstream financial services and the institutions that run these services like commercial banks, investment banks, and Fintech companies. TradFi is centralized and regulated by government agencies. TradFi services adhere to strict Know Your Customer (KYC) and Anti Money Laundering (AML) rules and exclude retail investors from many financial services accessible through DeFi.
- Decentralized finance (DeFi) describes blockchain-powered financial services that are open to all without the influence of intermediaries.
- TradFi refers to mainstream financial services characterized by centralization and regulation.
- TradFi and DeFi offer similar financial services but differ in terms of mode of operation, accessibility, and regulation status.
- TradFi and DeFi both use fintech to finalize transactions and provide similar services to consumers.
- TradFi and DeFi have found ways to operate in symbiosis via protocol-app integration despite their fundamental differences.
Main Differences Between TradFi and DeFi
TradFi and DeFi systems deliver the bulk of financial services today and provide similar offerings for their users.
However, there are some key differences in their mode of operation.
DeFi services are decentralized and trustless, thanks to blockchain technology and smart contract integration. With DeFi, smart contracts replace the middlemen, and users trust the public blockchain to execute the services promised by the protocol.
Unlike DeFi, TradFi embraces centralization by relying on governing bodies and regulators to provide a system of trust. This approach to finance comes with the drawbacks of financial exclusion and overhanded regulation, which may hinder innovation.
The heavy-handed restrictions associated with TradFi have made it inaccessible to many individuals, now referred to as the 'unbanked' population. The high barrier to entry limits the number of people that can partake in traditional finance services.
DeFi is open and transparent without the barriers to entry present in TradFi since there are no centralized entities governing it. The far-reaching capabilities of the technology promote financial inclusion, allowing anybody to partake in the system.
TradFi systems are heavily regulated with different requirements necessary for participation. The centralized governing bodies that oversee TradFi may require users to provide authorization from regulators and official licenses, or complete KYC or AML procedures.
DeFi does not rely on a central regulatory body to ensure trading and asset exchange. Therefore, transactions are seamless and hassle-free. A DeFi platform gives traders control over their assets and wallets. Provided you have a wallet; anyone can use DeFi. However, lack of regulation and anonymity exposes DeFi to the influence of bad actors like rug pull scammers and hackers.
Other differences lie in both systems' yield rates, profitability, and service offerings. DeFi generally offers higher yields than traditional systems and certain unique financial services like yield farming and staking.
Similarities Between TradFi and DeFi
DeFi's entry into the financial landscape primarily revolves around providing a viable solution to the TradFi legacy system and its restrictions.
However, despite having different operating mechanisms, both finance concepts still have certain similarities.
- Technologically Backed Transactions Both TradFi and DeFi systems leverage technology to facilitate transactions. DeFi uses blockchain solutions like Ethereum, Solana, or Cardano to power its services and protocols; TradFi also depends on messaging networks like SWIFT to transmit information about financial transactions on a global scale.
- Common Financial Service Offerings Another converging point for TradFi and DeFi is in the broad range of financial services that both offer. Although there are some products that are unique to DeFi only, users of both systems can access similar financial services like lending, borrowing, margin trading, payments, and spot trading.
- Integrated Payment Solutions TradFi and DeFi systems offer clients integrated payment solutions with automated payment services. However, TradFi currently provides the bulk of these services, but DeFi solutions like Wyre and DePay are catching up.
Could DeFi Become the Future of Finance?
With the merits it brings to the table and its tremendous growth, some experts think that DeFi may replace TradFi systems in the future. For this to happen, DeFi-related problems like scalability, liquidity, security, and lack of regulation must be resolved before its services can go mainstream.
However, while DeFi and TradFi are fundamentally different, current trends indicate that these two systems can work together. Traditional banks have begun to recognize the potential of DeFi. Some are working on crypto-related services for clients, while others are building integrations that allow consumers to use DeFi protocols within TradFi applications. This growing symbiosis between TradFi and DeFi breeds innovation and could open the door for the mainstream use of cryptocurrencies.