Decentralized Versus Traditional Finance

Those who promote decentralized finance or DeFi say that it is not only an alternative to the traditional finance network but more fair and more efficient. With concepts like the blockchain and freedom from government oversight DeFi can seem very bright, shiny, and new. But when we look at decentralized versus traditional finance, we see that Defi borrows heavily from “TradFi” and some of what it has borrowed are the bad parts! A Bloomberg podcast discussed DeFi vs TradFi and helps shine some light on the subject.

The Argument for DeFi

Many people throughout the world are excluded from banking and access to the financial sector. A system that runs on the internet using a decentralized blockchain only requires access to the internet instead of a financial grilling by a bank or other lender. Individuals who are not interested in having an institution looking over their personal finances are attracted to the concept of a decentralized and more democratic system. DeFi has the potential to revolutionize how we deal with finances in an open, secure, and transparent manner.

Decentralized Versus Traditional Finance

Where DeFi Copies TradFi

The way that banks make money is by taking deposits for which they pay interest at one set of rates and then lend out money at higher rates. However, banks and other financial entities also find ways to leverage their capital and make bigger profits than are generally seen in traditional banking. Every so often the banking system gets in trouble like it did after 1929 and again during the Financial Crisis. Regulators and Congress step in, write new laws, and enact new regulations to protect bank customers and investors in the financial system.

The same may be necessary in DeFi and regulation is on the way. In the Bloomberg podcast they point out that DeFi systems and stablecoins that went under have generally been very highly leveraged. They have not had the sorts of reserves that the banking system demands of banks. In addition, blockchain based DeFi systems may have been run on a decentralized physical framework but the management and business structure of many has been as highly centralized as any large bank and more like a risky hedge fund looking to swoop in and gain stellar profits by manipulating the monetary system.

Where Decentralized Finance Can Outperform Traditional Finance

Most people find DeFi attractive because, in theory, it will bring more people into the financial system and cut out the “middlemen” who profit because they control the system and not because they provide more benefits and better service. However, in order for this utopian world to come to pass the system will need to be regulated just like with banks, the stock market, commodities trading, and real estate transactions. Regulation will not keep those who currently have no access to banking, loans, or other financial system benefits. What it will do is protect anyone who uses the new system for their benefit.

The Future of DeFi

The ideal situation will be that decentralized finance extends the best of traditional finance to those who are currently not served by the traditional financial system and provides needed transparency. And that it comes under sufficient regulation to prevent scams by those who use blockchain based DeFi as a cover for highly centralized, highly leveraged online financial businesses with inadequate reserves.

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