Traditional banking is the poster child for centralized and highly regulated financial services. Decentralized finance systems represent the complete opposite. But can they coexist, or will one dominate?
Join us as we examine the worlds of decentralized finance vs traditional banking, in search of an answer.
Traditional banking, in a nutshell, is in-person banking at a physical branch of an established financial institution. In recent years, many traditional banking services shifted online, in keeping with society’s adoption of more digital solutions.
These have not replaced in-branch services, but offer greater accessibility and convenience alongside conventional in-person services. However, banks often still require customers to come into branches with identification documents after opening an account online.
Traditional banking is an example of a centralized financial system, with all banks under a centralized authority. In the US, the Federal Reserve Bank is the central bank that oversees and manages all the other banks in the country.
What is Decentralized Finance (DEFI)?
Decentralized finance seeks to move away from the centralized system of traditional banking.
Like the new digital banking services, it offers greater accessibility and convenience. Anyone with an online connection can transact. However, that is where the similarity ends. In decentralized finance, there is no need for a bank as an intermediary.
DeFi is a peer-to-peer financial system that uses Blockchaintechnology and cryptocurrencies.
Defi is not run by a central authority, as in traditional banking. Rather, it is run by code on a Blockchain.
A blockchain is a distributed and secured database or ledger, where transactions are recorded in files called blocks. These transactions are verified through automated processes, upon which the blocks are closed and encrypted.
New blocks are created with information about the previous block and newer transactions. And the blocks are repeatedly “chained” together in this way, hence the name. Because the information in preceding blocks cannot be changed without affecting successive blocks, this system is typically very secure.
Cryptocurrency is the currency used on decentralized finance platforms. Bitcoin and Ethereum are examples of these crypto coins.
Cryptocurrency is so-called because it is a digital or virtual currency secured by cryptography. This makes it almost impossible to counterfeit. Security in cryptocurrency transactions is further enhanced with Blockchain.
Cryptocurrency transactions are typically fast, affordable, and secure.
DeFi Solutions to Common Problems
DeFi’s unregulated nature and the anonymity of cryptocurrencytransactions raised concerns about fraud, money laundering, and other financial crime issues. Regulation by a centralized authority offers security, after all. These are issues that need to be addressed if DeFi wants to replace conventional banking.
That said, DeFi systems like Blockchain offer solutions to many common problems.
For example, it can be used for more efficient and secure Know Your Customer (KYC) processes. And KYC, a regulatory process by which banks verify their clients’ identities, needs a secure solution. But DeFi is certainly not the only solution.
The best KYC software offers an affordable, highly automated system of identity verification with continuous risk monitoring.
Is DeFi a Threat to the Traditional Banking Sector?
Decentralized finance is most certainly a challenger to centralized, traditional banking.
But is DeFi a threat to the traditional banking sector? An interesting survey was carried out on this topic amongst banking industry members. It found that 36% of respondents considered DeFi more of an opportunity than a threat.
More research may be warranted, but the banking sector does not seem to view DeFi as a threat. Most people have a limited knowledge of DeFi and are reluctant to abandon the comforting familiarity of traditional banking.
Will conventional banks maintain their historic monopoly? Perhaps not, but it’s also not going to disappear into the night, leaving DeFias the only option. This brings us to our original question: can these systems co-exist?
Can centralized finance (traditional banking) and decentralized finance, coexist? We believe they can, and more importantly, perhaps they should.
Centralized systems, with their regulatory process, offer better security and peace of mind. They are widely accessible, even to consumers who are not the least bit tech-savvy. And with the rise of digital-first banking, traditional banks are now more accessible than ever.
However, there is also much to be said for decentralized systems that allow users more control over their data and assets. Blockchaintechnology is offering innovative solutions in various industries, even in real estate transactions.
Although these two systems are opposites, they each fill specific needs. When they meet in the middle, consumers will enjoy the financial services they deserve. However, this will depend on the successful integration of cryptocurrencies into traditional banking systems.
Want to know more? Check out our guide to the future of cryptocurrency.
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