Decentralized Finance(DeFi) vs Traditional Payment Institutions

Decentralized Finance(DeFi) vs Traditional Payment Institutions
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With the rising craze for blockchain technology and decentralized finance (DeFi), which promises to provide traditional financial facilities like payment options and loans without any lengthy transaction process or high fees from a bank, trade groups for banks are concerned about the high risks involved in decentralized finance. As the foundation of blockchain is laid on decentralization, it eliminates the middleman earning fat fees.

What led to the emergence of DeFi is the need for a secure and transparent financial system. Decentralized finance can emerge as an alternative to the current traditional finance system.

What is Decentralized Finance?

Decentralized finance (DeFi) is a system through which financial products or services can be available on a decentralized blockchain network; it makes DeFi open to everyday use without facing middlemen like banks or brokerages. DeFi is a system in which lenders, sellers, buyers and borrowers directly interact with a software-based mediator instead of a company or institute. A decentralized finance system can consist of open-source technologies like proprietary software and blockchain. DeFi systems are mainly designed to remove intermediaries between buyers and sellers or any transacting party.

How is DeFi different from traditional institutions?

The difference lies in three points.

  • Decentralized finance is transparent and more open than traditional finance. Anyone with good programming skills can build tools and financial services on top of public blockchains.
  • A public blockchain acts as the source of trust in decentralized finance; the blockchain governs all the operations in the financial sector. In contrast, traditional financial institutions are governed by law and hold up the trust of the people, governing all operations.
  • The traditional financial system involves many entry-level barriers, including proper licensing and authorization from regulators, which leaves conventional institutes with little scope for innovation.

Financial bureaucracy has been a burden on traditional finance systems; decentralized finance stands out as an alternative by providing digital ledger technologies, making it possible for people to gain complete control of their data and assets while transacting in the global financial sector. Decentralized finance allows the developers to work round the clock without any restrictions and innovate new financial instruments capable of handling digital assets without limitations.

DeFi as a financial system

  • Decentralized finance has no geographical barriers; by using digital ledger technologies, people from any part of the world can utilize banking services through their mobile. Therefore DeFi can succeed in areas where traditional finance hasn't.
  • Decentralized finance is gaining popularity because it removes restrictions and bans imposed by centralized financial institutions that impose strict regulations that might not be very convenient for people across borders to transact businesses. Example- Ripple
  • The high scope for innovation in digital ledger technologies makes DeFi a reliable tool for future developments in financial products.

Like any other technology, Decentralized finance is also prone to challenges. The biggest challenge could be forcing people to trust unregulated source codes. In DeFi, anyone can access the source code, making it prone to hacking smart contracts and people losing a considerable amount of money.