There are two philosophically differing banking systems in the world today- Traditional finance (TradFi), consisting of the major banks, credit unions, and national financial systems, and Decentralized finance (DeFi), consisting of decentralized exchanges, DApps, and other institutions lacking middlemen. The two systems are both widely used. There are nearly five million individual DeFi accounts participating in markets estimated to be worth more than fifty billion dollars. In TradFi, it is estimated that seventy-six percent of humanity has a bank account, with some striking regional differences. In Japan for example, the number is ninety-eight percent.
To understand, we must look at why DeFi exists, how it relates to TradFi, what happens when DeFi doesn’t work, and what it can learn from TradFi.
Why DeFi exists- TradFi’s failures
It is well known that the white paper establishing Bitcoin was released in the aftermath of the 2008 financial crisis. Less well known is that the genesis block of bitcoin, block zero, included the text “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.” This is widely considered to be a comment by Satoshi Nakamoto on the failures of the traditional banking system. A critique of TradFi is built into the very bones of DeFi and related systems.
Of course, the Bitcoin ecosystem is not designed to allow for DeFi protocols. The rise of DeFi can be traced back to the launch of Ethereum in 2015. The ability of the Ethereum system to handle smart contracts is what truly makes decentralized apps, and by extension DeFi, possible. Ideas which existed even before the launch of Ethereum, such as Maker, were able to come into existence. ICOs and DeFi exchanges followed later. Today, there are many apps and operations that exist on multiple chains. Some are well-established and handle large amounts of money, while others are newer and innovate on existing ideas.
The birth of DeFi has not caused the death of TradFi. It continues to this day in largely the same fashion as shortly after the crisis of 2008, with only a few new regulations and meaningful changes. TradFi continues to have many of the same issues that it had in 2008. For example, banks often charge high fees for simple activities. These fees do not always prevent failures. At the time of this writing, the traditional banking system is facing a crisis that proves difficult to contain.
The collapse of Silicon Valley Bank (SVB) is the second-largest bank failure in American history and marks the start of a series of issues in the banking sector. In Switzerland, Credit Suisse is being purchased by UBS in order to prevent the collapse of the former. According to the New York Times, the Bank Policy Institute considers the SVB collapse “primarily a failure of management and supervision.” In a turn that reminds us just why bankers are often not trusted, the executives of SVB gave themselves large bonuses just before their bank failed. Clearly, the traditional banking sector remains highly flawed.
However, DeFi shows that a financial system based on a different set of values with different operating systems is possible. In doing so, it provides a sharp critique of TradFi.
How DeFi and TradFi differ
Before we go any further, we must consider the similarities and differences in DeFi and TradFi.
TradFi is subject to far more regulations, meaning that many elements of DeFi, such as the possibility of total anonymity, are impossible. In TradFi, money is held by banks that carry out requests for customers. Their networks are overseen by central sources. In DeFi, anonymity is often possible. The customer holds their own money and often directly interacts over a DeFi network with the person they want to send money to or otherwise do business with.
While they offer many of the same services, many of the most common banking services are still comparatively rare in DeFi. For example, cases of DeFi mortgages on homes are difficult to find- though they do exist.
What DeFi is supposed to do
The rise of DeFi is impossible to separate from its ethos. DeFi apps and exchanges allow for financial services to be offered in a radically different way than how TradFi institutions offer them.
Typically, DeFi is:
Decentralized: DeFi typically allows for individuals to interact with one another directly. This is made possible through a number of systems, including peer-to-peer networks. This means that the many services DeFi offers, such as loans, trading, or transfers, are occurring between connected people without a middleman. This often leads to faster transaction times and lower fees.
Autonomous: DeFi allows for a high level of autonomy. The customer holds their own money, controls what smart contracts they are and are not interacting with, can move their wealth at any time, and can review the records of their favored institutions at any time.
Trustless: As is the case with many blockchain systems, the autonomy the user has combined with the immutability of the records and iron law of smart contracts means that a much lower level of trust is required. Compare this to traditional banks where users have to trust their money is being invested wisely.
Transparent: Like many other applications based on blockchain technology, a record of all transactions is easily available. While management styles for Decentralized institutions vary, many of them are comparatively open.
When this works, individuals have the ability to use a number of financial services at low cost, at any time, and with the full knowledge that a combination of safety features and well-written code prevents theft or misuse of funds. While not all of the same services are as readily available in DeFi as in TradFi, many are, and it is not unreasonable for a DeFi user to expect to be able to take care of many of their financial needs using the Dapp or DeFi exchange of their choice.
The Benefits of DeFi
These values tend to lead to certain service options and applications for DeFi systems. As a result, DeFi tends to offer a number of advantages over TradFi. It is permissionless, often anonymous or nearly so, tends to have lower fees than TradFi, and allows for the individual to engage with the banking system, such as directly offering loans to other users, in ways that TradFi does not.
Additionally, while TradFi institutions tend to offer very low-interest rates, even after the series of interest rate increases by the Federal Reserve, DeFi protocols still provide a considerable yield advantage over TradFi institutions. Prominent DeFi protocols like Curve, Yearn, and AAVE showcase the potential of decentralized finance. While mainstream coins or stablecoins might not boast high yields, certain new tokens offer remarkable returns that are virtually non-existent in TradFi.
Bella Protocol’s Flex Savings, for example, offer APYs ranging from eight to over seventeen percent. Even protocols with lower rates, such as Curve, have many pools where the base APY is well above the .24 percent that a savings account in the United States currently averages.
Of course, DeFi isn’t perfect. In our next article, we’ll take a look at what DeFi could learn from TradFi and consider what happens when DeFi fails.
Bella Protocol provides a suite of DeFi products for auto-compounding yield and developer tools for building DApps integrating Uniswap AMM. The main product, Bella Flex Savings V2, is a trusted smart mining product that allows users to experience low gas and management fee, auto return, token burn, and considerable yield farming incentives. Flex Savings V2 has been running on Ethereum for over 20 months, with the highest TVL of over $40 million.
Bella’s core team recently completed building a developer tool — Tuner. This programmatic Uniswap V3 simulator allows strategy backtesting on a transaction-to-transaction basis with arbitrary or historical data without the EVM. It runs independently yet completely retains the exact smart-contract behavior of the intricate design and implementation of Uniswap V3. Tuner now has 32 forks and 101 stars on GitHub.
Bella Protocol is backed by Binance Labs, Arrington XRP Capital, and several other renowned investors.
For more information about Bella, or to join our team, please contact us at firstname.lastname@example.org
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