What is Traditional finance (TradFi)?
Traditional finance refers to systems controlled by centralized institutions like banks, governments, and brokerages. This is also known as traditional finance (TradFi).
In the world of finance, there are a few different systems that allow for an exchange of funds, each with their own distinct features.
Most of us are probably familiar with using centralized financial services like banks which hold and invest our money.
Traditional finance companies store funds centrally. They act as intermediaries for activities like transactions, trading, loans, and insurance. These institutions charge fees and require you to share personal information to have an account.
Most critically, TradFi institutions take your money and use it to invest, then keep the profit earned from those investments.
What is Decentralized Finance (DeFi)?
Decentralized finance aims to offer similar financial services as TradFi, but without centralized intermediaries. DeFi uses blockchain technology like Ethereum and Arbitrum to facilitate peer-to-peer transactions through smart contracts.
With DeFi, individuals maintain control of funds through private keys – there are no centralized parties managing accounts or assets, so transactions occur directly between peers.
DeFi also allows for anonymity – you may not need to provide personal information to begin trading.
Finally, DeFi allows individuals to take part in the investment process by investing directly into liquidity pools and into the platforms themselves, and benefit from those investments.
How Decentralized Finance Works
Users interact with DeFi primarily through decentralized apps (dApps) built on blockchains like Ethereum.
Some common DeFi activities may include:
Adding crypto into liquidity pools
Lending out crypto to earn interest
Borrowing funds instantly without paperwork
Trading crypto assets peer-to-peer
Accessing alternative financial instruments
Comparing Key Differences
Some of the major differences between the two models are that:
TradFi keeps all of the profits from your investments, DeFi shares it with users
TradFi requires personal information, DeFi can be anonymous
TradFi transactions go through institutions, DeFi is peer-to-peer
TradFi holds funds centrally, DeFi gives individuals asset control
TradFi is backed by government, DeFi is backed by individuals
Benefits of Decentralized Finance
DeFi has many unique beneficial features, such as:
Earn higher returns - DeFi interest rates can be higher than traditional savings accounts.
It’s open to anyone - You just need a crypto wallet to participate, no paperwork required.
You remain anonymous - You don't need to provide personal information.
Full control - You can move assets anytime without permission or delays.
Transparency - All transactions are viewable on the public blockchain ledger.
Pros and Cons to Consider
While traditional finance offers some benefits, decentralized finance provides more direct access and control. Both have unique risks and advantages – it’s ultimately up to the user to decide which may a better fit for their needs.
Decentralized finance is still a relatively young industry, which will continue to improve and adapt over time. While there are risks in participating in an emerging technology, Defi provides an important investment opportunity for users.
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