What is TradFi?

TradFi is a term used in the cryptocurrency community to describe the traditional finance system. Often, TradFi is contrasted with DeFi, which is a shorthand for “decentralized finance”. In this article, we’ll explore what TradFi is and how it compares to DeFi.

What is TradFi?

The term TradFi is very broad — it doesn’t just refer to banking, but also the stock market, the bond market, forex market, insurance companies, venture capital and other activities related to traditional financial services and investing.

Depending on the jurisdiction, TradFi businesses and markets are subject to strict regulations and compliance requirements. For example, banks are required to maintain KYC (know your customer) and AML (anti money laundering) measures.

The term TradFi is almost exclusively used in the crypto community. Most often, the term has a negative slant, as many crypto proponents believe DeFi (decentralized finance) is capable of fixing most of the problems present in the traditional finance sector.

Some of the most common issues that TradFi is criticized for include centralization, extreme concentration of wealth, high barriers to entry, alleged corruption and the influence of politics.

What is DeFi?

DeFi is a shorthand for decentralized finance, which refers to an ecosystem of decentralized financial applications. These applications exist as smart contracts on blockchain platforms, most often on Ethereum. However, any blockchain that supports general-purpose smart contracts can be used to deploy decentralized finance apps.

Smart contracts are transparent and immutable pieces of code that are deployed on a blockchain. They can be used to create decentralized lending platforms, decentralized cryptocurrency exchanges, NFT marketplaces and a whole host of other applications.

When you’re using DeFi apps, you’re not dependent on the whims of people or companies — you’re interacting with code that is publicly available and automatically and deterministically executes operations based on predetermined conditions.

This allows decentralized finance applications to introduce novel products and services. For example, you can trade between different cryptocurrencies without needing to deposit your cryptocurrency to a third party and having to trust that they will keep your funds safe.

Here are some examples of the most popular decentralized finance applications on the market today:

• Uniswap — Decentralized exchange protocol for token swaps
• Maker — A decentralized protocol that issues and manages Dai, a token pegged to the US dollar
• Aave — Decentralized lending protocol
• Lido — A protocol that allows users to stake their ETH and earn rewards while retaining liquidity
• dYdX — A decentralized exchange for leveraged perpetual contracts

According to decentralized finance aggregator DeFi Llama, there’s about $45.8 billion worth of assets in the decentralized finance ecosystem at the time of writing this article. At its all-time high in late 2021, this figure was as high as $179 billion.

While there is some merit to the crypto community’s negative view of TradFi and support for DeFi, it’s important to keep in mind that both TradFi and DeFi have their own benefits and drawbacks.

What is the difference between DeFi and TradFi?

The most obvious difference between DeFi and TradFi is how individuals access these two financial systems.

Individuals interact with the traditional financial system through institutions such as banks, insurance companies and stock brokers. Meanwhile, the decentralized finance system is accessed through smart contracts, which are essentially pieces of code deployed on a blockchain.

A company, for example a bank, could refuse to provide its services to a person for a variety of reasons. For example, you might live in a country that’s not supported by that particular bank.

Meanwhile, decentralized finance protocols are accessible to anyone, as long as they have enough funds in their crypto wallet to execute the transaction they’re trying to perform. Regardless of whether you live in the United States, Vietnam, Ecuador or any other place on the planet, you can use DeFi protocols such as Aave and Maker.

Another obvious difference is that traditional finance (TradFi) deals with fiat money such as the US dollar or euro, while decentralized finance (DeFi) deals with digital assets such as Bitcoin and Ethereum.

TradFi companies are required to adhere to regulations and can face serious consequences (at least in theory) for violating them. Customers who use banks and other financial institutions need to provide information about their identity so that the companies can conduct KYC and AML checks.

Meanwhile, DeFi exists in a largely unregulated space, as anyone is free to publish any kind of smart contract they want to a blockchain such as Ethereum. This is both a blessing and a curse — while it allows for rapid innovation, it also makes it possible for developers to create and publish predatory or seriously flawed financial products.

There have been countless examples of DeFi protocol exploits that led to massive losses for users. DeFi protocols are vulnerable to smart contract bugs, and they can also have flaws in their economic designs that savvy attackers can exploit to amass large amounts of money at the expense of regular users. Since cryptocurrency transactions are irreversible, users typically have very little recourse when it comes to getting their stolen funds back.

TradFi pros and cons

TradFi pros:

• Consumers have protections and legal recourse if they are treated unfairly
• Regulations provide a degree of stability
• Investors can easily access in concrete, real-world assets
• Investors have access to relatively low-risk products

TradFi cons:

• Some products are only available to accredited investors
• Regulations impede the speed of innovation
• Middlemen can result in relatively high costs for the consumer

DeFi pros and cons

DeFi pros:

• Accessible to anyone
• Users can maintain privacy
• The lack of regulation allows for extremely fast innovation
• Lack of middlemen brings down costs

DeFi cons:

• Lack of regulation makes it possible for scams and flawed products to thrive
• Riskier and more volatile than TradFi
• The DeFi ecosystem is largely self-referential and based on speculation

Please keep in mind that both TradFi and DeFi are loosely defined terms, and encompass a big range of financial and economic activity. So, the comparison we have outlined here is just a big picture overview and can’t possibly capture all the different products and services that can be categorized as either TradFi or DeFi.

The bottom line

If you’re active in the crypto community, you’ll hear the term TradFi quite often, even though it’s not really used anywhere else. Hopefully, this article helped you understand what TradFi is and how it measures up against DeFi.

If you’re interested in learning more about decentralized finance and the tools you can use to explore the DeFi ecosystem, check out our list of the best DEX screeners.

Source