Three Things That Make DeFi Different From TradFi
There’s a lot that connects decentralized finance and traditional finance. Both industries, after all, are concerned with the management of money and investments. In addition, both sectors cater to a mixture of consumers and institutions. At their heart, the two “Fi’s” are about finding ways to make your money work for you and exploring opportunities to generate profit through smart trading and investment.
But while the broad goals of DeFi and TradFi are closely aligned, they differ in terms of their methodology and infrastructure. In this article, we’ll consider three key differences between the two financial industries. But we’ll also explore their similarities and touch upon the projects seeking to pursue synergies, bringing TradFi products and services on-chain to the world inhabited by DeFi.
1. DeFi Doesn’t Sleep
Everyone knows that blockchains operate 24/7 and thus you can trade digital assets around the clock. Stock markets, on the other hand, are bound by precise opening and closing times. Many global stock exchanges, such as the NYSE, run from 9:30am-4pm. There are exceptions, though: the Saudi Stock Exchange operates from Sunday to Thursday, while Asian stock exchanges typically stop for lunch.
But what happens when it comes to trading synthetic assets on-chain that mirror stocks? Can you buy Apple stock – or a digital token mirroring its price – at 2am if the mood takes you? The short answer is yes, you can. In theory, the out-of-hours price of a tokenized stock should correlate to the closing price on the stock exchange it’s traded on.
In practice, there may be some movement from the last official price when you’re trading a synth on-chain, but when the TradFi market reopens in the morning, its DeFi equivalent will quickly find parity. Products such as dAssets on DeFiChain enable you to trade tokens around the clock with close parity to the underlying stocks and ETFs’ price. Even when the stock exchange is closed for business.
2. DeFi Settlement Is Final
Blockchain transactions are irreversible. That’s a feature, not a bug, and is one of the reasons why assets such as bitcoin have become so valuable. When you send crypto over a blockchain network, you do so with complete confidence that the transaction isn’t in danger of being frozen, canceled, or rolled back. This contrasts with TradFi, where transaction finality is weak. Take forex markets for example.
In theory, you can’t trade more than you have in your broker account. In reality, it’s possible to wind up majorly in debt when a trade goes the wrong way and you’re margin called. In extreme cases, traders have wound up owing tens of thousands of dollars to brokers, causing a further headache should they then default on the debt.
In DeFi, everything is settled on-chain, meaning it’s theoretically impossible to borrow more than the value of your collateral, or to get liquidated for more than the value of the assets you have to hand. There are certain edge cases where DeFi protocols have wound up undercollateralized, such as NFT lending platforms, but in such rare scenarios, it’s not the user who’s on the hook for the monies owed – it’s a platform problem.
3. DeFi Doesn’t Discriminate
There’s an old meme that goes “On the internet, nobody knows you’re a dog.” When applied to DeFi, this means that it’s almost impossible to discern the identity behind a particular wallet or user profile. There’s a caveat to attach here: some DeFi protocols are obliged to perform KYC for legal purposes, in which case there is a clearly identifiable person attached to the wallet making the trades.
By and large, however, compliance isn’t required of individuals making low level transactions in the DeFi space. While this is good for personal privacy – no data retention requirements mean there’s no doxxable information to be stolen by hackers – it’s even better for equality.
It’s no secret that in traditional finance, people are sometimes excluded from participating on account of their nationality, locality, ethnicity, income, gender, or even sexuality. In DeFi, everyone is treated equally: whether you’re a dog, cat, or human makes no difference to the smart contract processing your transaction.
Which System Is Better?
While we’ve focused on features that differentiate DeFi from TradFi here, it would be premature to assert that this automatically makes decentralized finance “better” than traditional finance. “Different” would be a fairer description. Despite its many attributes, DeFi also has its downsides it should be noted, from smart contract risk to a lack of consumer protection. Thus the two systems should not be viewed as opponents locked in battle for supremacy. Rather, they can be regarded as complements.
DeFi does things that TradFi cannot and vice-versa. It’s no surprise, therefore, that a number of on-chain protocols are seeking to capture the best of both worlds: the liquidity and uncorrelated assets synonymous with TradFi coupled with the many benefits that come as standard with DeFi. In the near future, these two ecosystems are less likely to compete than they are to coexist.