The future of Finance: Traditional or Decentralised?
When Satoshi Nakamoto pitched the idea that started the cryptocurrency revolution, he had one goal in mind and that was the replacement of traditional financial institutions by a more viable and fair financial system and the new system that was birthed from this proposal was decentralized finance. In the years that have followed that initial introduction, we have not only seen the decentralized finance sector grow but have seen it challenge traditional finance in many areas. With the many successes achieved by the decentralized finance model, it is only natural for people to start wondering if decentralized finance is the future and what role traditional finance will play in such a future. The question on so many minds is, will traditional finance be replaced by decentralised finance?
But before speculating on what the future may bring, let me provide a brief introduction to these two financial models for those who may not be familiar with them.
Traditional Finance refers to the regular banking and economic systems that we have been using for the past few centuries. These are basically centralized institutions, either government or private, that handle the production, allocation and transfer of money. They generally are represented by banks and investment firms.
Decentralized Finance (DeFi), on the other hand, refers to a new financial system that is largely based on computer technology. It utilizes concepts such as blockchain technology and smart contracts to create a financial system that is intended to be transparent and accessible to anyone without having to rely on third parties.
This article is not intended to go into the nitty gritty of the ideologies, techniques and operations behind these financial systems. Our aim is to find a satisfactory answer to the title of this article. Let's now take a look at a summarized comparison between these two financial systems based on their advantages and disadvantages.
Traditional finance has been in existence for a long period of time and this has given it enough time to refine the processes that make it work. This refinement, backed by regulations and oversight, provides a platform that gives confidence to customers that utilize the financial services offered by these institutions. And that is the primary advantage of traditional finance, stability and reliability. However, this reliability of traditional institutions comes at a cost. In other to function smoothly, traditional finance makes uses of third parties at multiple levels and each of these third parties come at a cost. The end result is higher costs and unnecessarily long processing times. More vexing is the fact that most traditional financial institutions operate like elite clubs and choose and determine who gets to benefit from their services. Not forgetting, that the dictatorial nature of governance in these institutions sometimes leads to involvement in fraud and other illegal acts.
The advantages of decentralized Finance stand in opposition to the disadvantage of traditional finance. The high cost of traditional finance is reduced since DeFi does not rely on multiple third parties. Then there is the issue of inclusion, whereby, everybody has access to financial services irrespective of their standing. Also, the propensity for fraud is greatly reduced due to the overall transparent nature of the decentralized system. But there are drawbacks too. The major drawbacks of DeFi are ease-of-use and security/privacy issues. Most DeFi tools are quite complex and not easily understood by every user. Add to this, the lack of security and insurance due to the largely unregulated nature of DeFi.
Many other points could be made (both for and against each financial system) but I will limit myself to those I mentioned above.
What I think will happen.
Once upon a time, humans traded via direct exchange of goods and services. The introduction of money eased the awkwardness associated with the former trade method. Before long, substitutes such as gold and silver became money due to their intrinsic properties. But as society evolved, other forms of money (such as paper notes, bank cheques, IOUs, etc) that were more feasible were developed and used. I see history repeating itself and the same thing happening with DeFi. Decentralized finance presents that next step in the evolution of financial services. But the looming question is, will it replace traditional finance completely? My answer is no! Rather what I think we will get is a hybrid system whereby certain aspects of traditional finance will be replaced by DeFi concepts while the other aspects that have been known to be reliable will still be upheld. In the end, we will likely no longer distinguish between traditional finance and DeFi but will have a single financial system that incorporates the best elements of both systems.
Thanks for reading.
