In this article, we will be looking at the various features that make DeFi a safer financial system than TradFi. But before then, let’s get to know what the two financial systems are. DeFi systems are decentralized platforms mostly built on smart contracts for carrying out financial services including lending and trading. They are designed to be transparent, uncensorable, and they execute orders automatically and independently on distributed blockchains. Smart contract-based DeFi services have an on-chain feature that is accessible to everyone with some crypto holdings and internet connection.
However, TradFi is a centralized financial system monitored by humans. The term TradFi was coined from Traditional Finance with the advent of DeFi. The system is made up of conventional financial institutions like insurance companies, banks, asset managers, and so on.
Why DeFi is More Secure Than TradFi
Traditional Finance is characterized by the issue of centralization (monopoly of power), complexity, and a couple of malpractice incidents. This has gradually led to the collapse of the entire system and people no longer trust the process. However, DeFi came as an alternative allowing people to control and decide over their money. It operates in a decentralized, trustless, and permissionless manner. Here are the features that make DeFi better.
All transactions in the DeFi ecosystem are transparent. They allow access or visibility into their order books and loans including liquidation points. For instance, you can track all your bitcoin transactions just by looking at the blockchain records. This is unlike TradFi where most of the transactions are done underground. The banks loan out actual funds while the visible figures become IOU from the bank.
DeFi operates with strict policies on loan collateral to help maintain the stability of different platforms. To that effect, the system gives its users an extremely conservative borrowing limit although there could be an insufficiency of capital. But, TradFi systems have fewer restrictions, and they leverage their reputation.
DeFi loans, however, require that collaterals are effectively locked in the systems to prevent users from using them multiple times. Re-pledging collateral for multiple loans could be fraudulent but TradFi and other centralized financial systems may not detect it.
Automated and Transparent liquidations
DeFi systems can be set to liquidate loan collaterals automatically since they are already locked in there. This automated process takes place before the collateral goes below the loan value. Meanwhile, TradFi adopts analog or interpersonal processes. The centralized leader’s issue margin calls for borrowers.
Transaction Cost and Speed
DeFi loans are on-chain with prompt liquidations at little or no cost. But in traditional lending, the interpersonal process is very slow and expensive. It takes hours or even days which may give room for lots of imbalances or flours. The opportunity cost a user bears for a transaction in TradFi is very significant.
Although not without a few flaws, Decentralized Financial systems are gradually gaining people’s trust more than TradFi. The potential of blockchain technology in the financial industry can not be disputed. DeFi came to revolutionize the financial sector with its problem-solving capabilities. This largely explains why many TradFi systems today are gradually adopting the DeFi processes.
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