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DeFi versus Traditional Finance: Can Defi Become a Viable Alternative to Traditional Finance?

Estimated reading: 5 mins

DeFi versus Traditional Finance: Can DeFi become a Viable Alternative?

Can DeFi (decentralized finance) become a viable alternative to the traditional way we’ve always handled money?  It's an interesting question, and with the popularity of DeFi quickly growing, it needs an answer.  In this article, I’ll be going through the primary reasons I think DeFi can be a viable alternative to traditional finance.  To do that, we first have to ask, "what exactly is decentralized finance?"

 

Decentralized Finance

Like EFTPOS or payWave, many people see DeFi as a literal game-changer regarding financial technology and how we'll handle our finances moving forward.  Much of that has to do with the fact that DeFi is largely unregulated, meaning that it's not controlled by large banks, governments, or other financial institutions.  It eliminates or minimises financial barriers that we usually associate with dealing with money, such as late charges, lengthy transaction times and expensive fees.

Regarding how people buy, sell and deal with currency, I think it would be a complete understatement to say that its introduction will change the financial landscape as we know it.  DeFi eliminates the unnecessary paperwork that comes with dealing with intermediaries and replaces them with smart contracts.  A smart contract is a tiny programme embedded into blockchains that are automatically triggered when transactions or specific criteria are completed.

One example is the field of insurance.  At the moment, an argument could be made that using insurance is an overly cumbersome process.  Smart contracts eliminate the paperwork and automatically handle the little details, making it a more seamless process.

 

Blockchain - What Is it?

A distributed database that can store information in a digital format (in this case, cryptocurrency).  Data are stored in what's known as a block; when the block's filled with data, a new one’s automatically created, forming a chain.  Once a block's created, it can't be altered, thereby creating a permanent record of the transaction, complete with a timestamp telling everyone when it was made and when the transaction took place and by whom.

All of this leads to perhaps one of DeFi's most significant advantages: it can't be tampered with or altered and is seen as a more reliable alternative to an increasingly growing number of people worried about being defrauded.

 

What wallet options are there to store the coin/token?

 Benefits of Keeping Your Money in a Digital Wallet Instead of the Bank

The Digital wallet or E-wallet is a software that replaces the need for debit cards and bank accounts and stores payment information and numerous passwords allowing users an easy way to handle their finances.  In 2020 it was estimated that in the United States alone, 55% of smartphone users now shopped via digital wallets due to the security and convenience they offer.

  • Whether online or at a retail store, digital wallets allow prompt payment, with some even offering you the option to top up with a linked banking app via your phone.  The convenience and the growing popularity of contactless payments make keeping your money in a digital wallet a much more attractive option than keeping it stored in a bank.
  • Digital wallet use jumped seven percent in 2020 with the trend expected to keep growing, with some predictions indicating that by 2024 they'll account for half of all e-commerce payments worldwide.  Approximately 7.1 million households are unable or unwilling to get a bank account for various reasons.  Digital wallets help by paying their household bills and day-to-day expenses without relying on a traditional bank or a loan sharking service.
  • Although digital wallets have a reputation for being safe (all data is encrypted, sometimes involving a two-step password), that doesn't make them entirely safe from theft or fraud. If lost or stolen, owners risk having their wallets hacked and their funds or identities stolen.

 

What Are the Security Risks of Decentralized Finance?

As stated at the beginning of this article, there are some compelling reasons why you should get into DeFi. Still, there are also some legitimate security concerns that you should consider before taking the plunge.  The truth is that nothing is truly 100% secure, and in the last ten years, the global market has experienced 226 different security breaches, with 10% of them happening in 2021.  In total, 12.1 billion was lost as a result. Significant security risks include:

  • Coding mistakes made with the blockchain can lead to more significant errors further down the line, leading to a loss of profits.
  • Errors made when creating smart contracts.  Smart contracts are simple programs embedded into the blockchain.  If a contract's poorly programmed, it can lead to severe consequences for everyone.
  • Leaked or stolen private keys.  Private keys are passcodes that allow you to access funds stored on blockchains.  Stolen or compromised keys are the most common security risk involving DeFi.  One of the best ways to avoid this is to ensure you only store them off of digital devices (e.g. on paper) abd use a secure random generator when first creating your passwords.

 

How Does the Lack of Regulation in DeFi Pose Risks?

One of the things that makes DeFi so attractive is that it's largely unregulated (for now), cutting out financial 'middle men' like banks and other third parties, but its very nature can carry risks of its own.  Because it's unregulated, there are no governing bodies overseeing transactions using blockchain, apart from the parties involved with the transaction.  When things go wrong, the blame and responsibility fall onto those said parties.  For many people, that can be a daunting prospect and one that may pose a risk to anyone unfamiliar with the ins and outs of dealing with financial liability.

According to blockchain analytics firm, Elliptic, over 10 billion has been lost due to DeFi frauds in 2021 alone.  The group highlighted several areas where they felt that DeFi was vulnerable, including highly leveraged trades, liquidity issues, and the lack of shock absorbers, and banks usually took this role.  In light of these statistics, a case could be argued that regulated decentralized finance is needed in light of the risk that fraudsters pose to consumers.

 

What Factors Are Driving Trends in Decentralized Finance?

The traditional financial system as we know it today has always been viewed as relatively slow. By comparison, DeFi is seen as lightning quick, which cuts out the big banks and the red tape.  The idea that a third party isn't involved and the perception that blockchain represents a firewall against scammers makes it a tempting prospect, especially in light of the increasing amounts of fraud that we see rising year after year.

One trend that is helping to drive the idea of decentralized finance is what a lot of experts are dubbing the meta or the metaverse: a digitally interconnected, virtual space where everything can be done online.  Companies like Facebook and Microsoft are already in the process of setting up their own versions of the meta, and it could only be a matter of time before DeFi overtakes traditional finance to become our new normal.

The environment and greenness have become a growing trend in recent years, especially in the corporate world.  While mining for crypto used to be a drain when it came to fossil fuels, in the early years, there are now many that use more environmentally friendly processes.

 

What Do Projections Show About the DeFi Industry in the Near Future?

According to an article published in Forbes, at the beginning of 2021, the cryptocurrency known as Ethereum was valued at under 800 million; last year, that value jumped up to three trillion dollars.

With inflation rates rising every year, cryptocurrencies like bitcoin are seen as the safer and less volatile option.  Some see the possibility of bitcoin rising to as much as 100 million this year alone.  Other cryptos will also increase, with the most significant rising well into the triple digits since 2021.

It's clear from these projections that DeFi has captured the public imagination, and a comparison can be made with the property market in New Zealand.  However, it's important to remember that, like every other currency, the rise may not last forever, and we have to remember that when dealing with it.

So, can DeFi become a viable alternative to traditional finance? It seems as the technology advances that it is indeed very possible.


About the author:

Kerry Lee

Disclaimer:

The above references an opinion and is for informational purposes only. Do not take this as personalised financial advice or investment advice. The views expressed by the author do not necessarily represent the opinion of BitPrime.

 

Last updated: 13/04/2022

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