DeFi vs Traditional Finance - Understanding Payment Institutions
DeFi vs Traditional Finance, what’s the difference? In recent years, developments in the cryptocurrency ecosystem have created a new, blockchain-based financing option. Decentralized finance, known as DeFi, is an alternative to traditional banking methods that is revolutionizing the way that borrowers, lenders, and investors interact. But if you’re new to the world of crypto, you may be left wondering: what makes DeFi different from traditional financing?
DeFi vs Traditional Finance
In the world of personal finance, there are two main camps: those who use traditional systems and those who use DeFi. So, what's the difference? And which is better for you? We'll explore the pros and cons of both systems to help you make an informed decision.
What is DeFi?
DeFi refers to a financial system where transactions are recorded and executed on the blockchain, without the need for a central authority. In this type of system, users don’t have to trust each other or depend on a third-party entity, like a bank, to verify transactions. Instead, every participant can verify the transaction using smart contract technology.
Smart contracts are stored on the blockchain and work by self-executing when specific conditions are met. Using this technology, developers build programs called decentralized apps, or DApps, which enable users to lend money, take out a loan, earn interest on your cryptocurrency, and more.
What makes DeFi different?
In the traditional financing system, your money is held by companies. Banking institutions manage your funds, and you have no ability to see their loan history or records of their managed assets. If you want to move your assets around, you do so on the bank’s timetable. In a nutshell, with traditional banking, you’re beholden to the bank and its policies and limitations.
The driving concept behind DeFi is that it isn’t managed by a banking institution. Instead, it relies on smart contracts to run without human intervention. Everything on the blockchain is available for the public to view, which builds trust with its users since anyone can verify the transactions.
DeFi is open to anyone, as opposed to banks where you must apply to use financial services, like opening a savings account or taking out a loan. And where banking institutions typically adhere to traditional business hours, the cryptocurrency market is always open. Instead of waiting days for a transaction to occur, like with traditional financing, transfers of funds happen in minutes under the DeFi system.
What is DeFi used for?
DeFi provides an alternative to most traditional financial services, but it also creates new financial products. Here are some ways DeFi is in use today:
Send Money Anywhere
Since DeFi funds exist on a blockchain, transactions can be sent anywhere in the world. Using your cryptocurrency wallet, all you have to do is enter the recipient’s account address and your payment goes directly to them in minutes.
There are two main ways to borrow money through DeFi: peer-to-peer and pool-based. Peer-to-peer allows a person to borrow directly from a lender and pool-based allows the lender to provide funds to a pool that the burrower can pull from. Both options work without either party having to identify themselves, so everyone retains their privacy.
The borrower is typically required to put up collateral that gets released to the lender if they fail to repay the loan. However, a new type of loan called a flash loan allows users to borrow without collateral. Instead, the loan is both taken out and paid back within the same transaction.
Access Stable Cryptocurrencies
The value of cryptocurrency is constantly fluctuating, but DeFi solves this problem with something called “stablecoins.” The value of each stablecoin stays tied to another asset, such as USD. For example, USDC has a value that stays within just a few cents of a US dollar.
Grow Your Portfolio
Fund management products allow you to grow your portfolio based on an investment strategy, much like traditional stock management companies. However, where stock management typically relies on human management, DeFi options are entirely automated.
An example of this is the DeFi Pulse Index Fund. This product rebalances automatically to make sure that your crypto portfolio always includes the top DeFi tokens. Using products like this, you don’t have to manage the details of your portfolio and can simply withdraw from your growing funds whenever you want to.
DeFi is ideal for crowdfunding new ideas and startups. Potential funders can come from anywhere and are able to track how much money has been raised and how that money is being spent. If a deadline hasn’t been met, fundraisers can even set up automatic refunds.
Cryptocurrency is changing the way we interact with money, and through DeFi, anything is possible. If you’re interested in learning more about crypto, be sure to check out our other guides today.
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