Until recently, there was only one approach to finance. However, since the explosion of decentralized finance in 2020, we are seeing that there is another way to interact with money and assets.
To see the implications of each, let’s compare different aspects of traditional and decentralized finance.
Definition
TradFi is short for Traditional Finance, which refers to the traditional financial system, while DeFi is short for Decentralized Finance, which refers to the decentralized financial system.
A financial system is the set of institutions that enable the exchange of funds. These institutions in the traditional financial system are banks, insurance companies and stock exchanges among others.
If you want to go deeper into DeFi look at our medium to see the article in which we explain in depth the decentralized finance.
As we can see from the names, the big difference between these systems is decentralization.
Decentralization
Decentralization refers to the fact that there is no intermediary agent such as banks in the traditional system. Funds transfers occur directly from one user to another.
In TradFi, people’s funds are held by entities such as banks or brokers, which are the ones that make the transactions, so when you want to make a transaction you have to contact these entities, fill out certain documentation, adjust to their schedules… Another proof of this is the SWIFT system, a network of banks from more than 200 countries that move their clients’ money among them.
In DeFi, on the other hand, it’s the other way around. Each person has their money under control, even if they use other companies to carry out functions such as lending or buying other digital assets.
In DeFi there are also companies that perform the functions of banks, insurers or brokers, but without controlling the clients’ money. These companies provide the infrastructure needed to do these operations, which is code, and people use it in exchange for a commission. The money is sent from one person’s digital wallet to another person’s digital wallet.
This has several implications that we will discuss later.
Privacy
In terms of privacy, TradFi and DeFi are very different.
In traditional finance, regulation is quite strong and widespread, so that regulators force all financial institutions to verify the identity of their customers.
This means that in order to open an account with a bank or broker you have to give a lot of personal data to the institution in question. In turn, this means that we lose control over our data since these entities can share our data or the data of the transactions we carry out with third parties without us knowing it or being able to prevent it.
The degree of privacy in decentralized finance is very different.
DeFi is characterized by anonymity. When a person creates his or her digital cryptocurrency wallet, he or she does not have to give any personal details.
What happens during this process is that a public key is generated, which is a set of random letters and numbers. The public key is what will identify a person in the blockchain transaction register.
Thus, although the transactions that have been carried out are available to the public, the identity of the people behind these transactions is not known.
In the second part we will compare these more aspects of TradFi and DeFi.
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