Finance newbies often wonder, what’s the difference between decentralized and traditional finance? How do they differ in terms of trading? And does DeFi have a future or is it just a trend? The truth is, modern technology has enabled safer, faster and more effective ways to do things, yet they are rarely understood, leading to lost opportunities. To figure out which is better when it comes to trading, let’s look at how financial systems emerged from TradFi to DeFi through history with their pros and cons.
Plato’s well-known aphorism, “Necessity is the mother of invention” aptly describes that the driving force for the majority of new innovations is a need. In light of the widespread acceptance of technological advances like Blockchain, Web3, Smart Contracts, and Cryptocurrency, it might come as no surprise that decentralized finance (DeFi) is becoming increasingly popular over the years.
On the other hand, traditional finance (TradFi) has a centuries-old business model that remains loyal to its longstanding ways of doing business. While the trading ecosystem may still be traditional, it is undergoing a shift as it becomes more vulnerable to threats while implementing new operational practices is delayed. Although traditional finance has a legacy, other industries continue to innovate and disrupt its old practices. As a result, traditional finance faces numerous challenges that make it difficult to remain competitive and relevant.
Today, more or less everything is digital ─ including traditionally analogue fields, like finance.
Technological advancements can quickly solve technological disadvantages and operational challenges in an industry prone to complacency. By digitally transforming traditional finance, all stakeholders will have a better experience, and by utilizing technology to streamline communication and expedite procedures, all operations are simplified and the industry is assured that its future is secure.
The purpose of this article is to discuss the pros and cons of the two most common forms of financial infrastructure while also looking at the crossovers between the two. Rather than competing, traditional finance and decentralized finance applications can work together to improve the financial system. Keep reading to find out how!
What is Traditional Finance (TradFi)?
The term “TradFi” stands for traditional finance, which refers to conventional banking and financial services.
Back then, trades were conducted with shells or beads when people agreed to exchange goods for each other, for example, tomatoes for meat. With time, needs have changed, and precious metals such as gold and silver became the mode of exchange before the advent of fiat currency. The word “Fiat” signifies “an order given by authority or arbitrarily”, and when it comes to “fiat money,” it is an order by the government that gives it value and legitimacy.
The Traditional Finance industry has remained essentially the same since the industrial revolution, with the trust placed in intermediaries such as banks, brokers, and custodians. In an industry still heavily reliant on paper, transactions can be notoriously complicated and lengthy due to the need for a paper trail between parties and validation of exchanges. Furthermore, due to the use of different systematic databases and platforms, trade between international buyers and sellers often results in misunderstandings and a sense of disconnect.
Despite efforts to improve operations, traditional trade finance capabilities are hard-limited by inefficiency. It is extremely time-consuming and expensive for all parties involved. This model requires an immense amount of human effort, a concept that is alien to today’s digital society accustomed to speed and convenience. Despite its reputation for being resistant to change and discarding traditional models that have served old status quos, the industry has slowly, but surely embraced change.
Overview of Traditional Finance Sector:
Today’s traditional finance system utilizes banks and financial institutions to provide these services. Borrowing, lending out money, earning interest on savings, investing, or applying for a mortgage usually requires the assistance of a bank, financial advisor, or broker. Although everyone is pretty familiar with this type of market, here are a few things you should know.
- The industry has gained tremendous popularity, with both individuals and businesses seeking additional funding for their needs.
- The banks bear full responsibility for the funds of their customers. It also includes the customers’ trust that their money will not be misused or given to unreliable borrowers, hoping that their money won’t be used for illegal purposes.
- There is a possibility that transactions may take up to several days to complete as they often involve manual procedures.
- Financial institutions and government bodies can view your personal data and you will be responsible for paying taxes.
- Markets are not available around-the-clock because the employees need to have days off and holidays.
As part of its transformation journey, the industry implemented small advancements like mobile banking applications and mobile payment services. Being technologically adapted is no longer an optional element for traditional finance, but a fiduciary obligation in the age of Fintech. Fintech has revolutionized the financial sector, from banking to investments, and now it is changing how traders participate in the forex market. Find out how fintech revolutionized the forex trading landscape here.
What is Decentralized Finance (DeFi)?
Decentralized finance (DeFi) is a system that makes financial products or services accessible to the general public through a decentralized blockchain network; it eliminates middlemen like banks and brokerages. Instead of interacting with a bank or government organization, lenders, sellers, buyers, and borrowers directly interact with a software-based mediator.
The evolution of Bitcoin started it all. In many ways, Bitcoin was the first DeFi application. When you use Bitcoin, you can send value anywhere in the world and own it. Unlike other currencies, Bitcoin is open to everyone and its rules cannot be changed. There is no printing of money and no closing down of markets like in traditional finance where governments and companies can devalue savings and devalue the value of your savings.
Various technologies can contribute to the implementation of decentralized finance (DeFi) systems, such as open-source software and blockchain. Any individual, from any part of the world, can access DeFi services instantly with an Internet connection and smartphone. It makes the cost of financial services more affordable since there are no intermediaries. They’ll have full control over their money and will earn better interest.
Generally, excluding third parties allows you to take advantage of a wide range of benefits, such as not having to deal with traditional financial paperwork. However, it is important to note that the decentralized finance sector does not have a regulator and is not regulated in most countries worldwide.
Overview of Decentralized Finance Sector:
The decentralized finance sector eliminates a number of issues associated with the existing traditional finance system. DeFi allows anyone with an internet connection to access financial services, with users typically owning and maintaining the assets. A few more features are listed below.
- Decentralised finance incorporates the benefits of traditional finance while also offering transparency- something traditional finance sorely lacks.
- The DeFi market is accessible to anyone. An Internet connection and a crypto wallet are all that are required for users to access the service. Traditional financial system users do not have such an opportunity as it involves dealing with intermediaries and submitting applications, among other things.
- All business transactions are open to the public. The conditions can be viewed by anyone without the opportunity to modify them.
- In order to use the service, users do not need to deal with third-party financial institutions. Thus, users are in full control of their personal information and funds. It is up to the customer to decide when and how to spend their money.
- Since all the transactions are conducted under pseudonyms, no personal information is disclosed about the users.
- It is possible to access the marketplace around the clock. It is possible for customers to access the services of this financial sector at any time convenient to them.
More specifically, DeFi makes financial services more affordable since no fees are paid to intermediaries. Yet, Decentralized finance is also susceptible to challenges, just like any other technology. It may be difficult to get people to trust unregulated source codes, which could pose the greatest challenge. Also, in DeFi, anyone can access the source code, making smart contracts vulnerable to hacking and resulting in considerable financial loss.
How Decentralized and Traditional Finance Work Together?
Both decentralized finance and traditional finance involve the borrowing and lending of money, just like any other financial undertaking. In fact, both systems can be utilized by the same individuals. While both fall under the finance sector, DeFi and TradFi do come into contact at times.
Decentralized finance platforms facilitate a wide range of financial transactions independent of traditional financial systems. All of its operations take place on the cryptocurrency market. And this is why DeFi cannot completely replace traditional finance. But they do interact occasionally. To be precise, lenders must convert their fiat money into crypto coins or tokens before offering their funds through DeFi platforms. Money is usually stored in a bank account first and then transferred to an e-wallet.
Decentralized finance uses smart contracts to connect its lenders and borrowers. While with traditional finance, parties use the services of the same intermediaries, such as banks, online service providers, etc.
Traditional Finance vs Decentralized Finance
Trading has been taking place on a global scale since the 18th century and has continued to be an excellent earning opportunity to this very day. Over time, especially in today’s digital era, with the availability of online trading coupled with the increasing number of assets on the financial market, financial trading is increasingly becoming popular with the general public.
While trading in digital assets and in traditional financial markets have a number of similarities, they differ on both fundamental and practical levels, which warrants contrasting assessments of value, risk, and opportunity. Let’s compare the trading aspects of traditional finance and decentralized finance one by one.
Trading in Traditional Finance Markets:
The traditional finance markets consist of various different assets like Forex, stocks, Indices, Energies, Metals (Gold & Silver), Commodities and so on. Among the other financial markets, the foreign exchange market, also known as the FX market, Forex market, or currency market, is very popular. It involves the exchange of national currencies against one another on a global scale. As an example, Euros can be exchanged for US dollars, or British pounds can be exchanged for Japanese yen.
Trading on the financial markets can be carried out in many ways, and it usually depends on what asset class you choose to trade. In order to participate as a trader in traditional financial markets, first, you have to choose your trading asset and open a trading account with a broker. Choose a broker that allows you to trade all financial assets on one platform if you want better returns and easier access. AximTrade stands out as the best broker in terms of its reliability and excellent trading conditions, offering Forex, Stocks, Indices, Metals, and Energies, and facilitating in-depth market analysis using various tools accessible through the MT4 platform.
A traditional finance market is an online marketplace where brokers, traders, and dealers trade financial securities and assets by using a broker’s platform. Trades are made directly between buyers and sellers. It is important to understand how traditional finance markets work, including their different exchanges and trade sessions, to be able to trade successfully. There are several large exchanges, including the New York Stock Exchange and the Chicago Mercantile Exchange. Foreign exchange markets, which trade approximately $5 trillion every day, are the most significant spot trade markets worldwide.
In traditional financial markets, the exchange is responsible for receiving and matching orders and maintaining a fair and orderly market. Instead of processing financial flows, exchanges process information transfers. Dedicated brokerage accounts are used to store funds and assets, with liability shared between the regulated entities: the exchange and a bank. Client funds are always stored in the broker’s segregated accounts and are never handled by the exchange.
We’ve put together a list of 10 Things You Should Know Before You Open A Forex Account to help you get started with trading more effectively. Check it out!
Trading in Decentralized Finance Markets:
Trading in the decentralized finance markets is nothing but crypto trading, in which one speculates on future cryptocurrency price movements through a trading account or buys and sells virtual coins for a profit. Though decentralized finance stepped into the world of investment several years ago, the crypto trading market gained its momentum in 2017 among both new and experienced investors alike and is now a leading investment destination with growing investment appeal every day.
Getting started with crypto trading involves signing up for a crypto trading platform, purchasing digital assets with your currency, and trading them for one another. In order to be successful in crypto trading, you should always choose the right platform and make sure you have the right tools for the trade. Read the advantages of Crypto Trading with AximTrade for a clear explanation of how the brokerage gives you a competitive edge through its ability to trade over 35+ cryptocurrencies.
Trading in the decentralized finance market can be extremely risky, as recent months have demonstrated. During times of market volatility, the value of coins is subject to sudden dips and increases. The good news is that even with such an unpredictable market, there are trading strategies so simple that even inexperienced investors can make money – crypto trading being one of them. The crypto market is all about finding opportunities, even during these times of volatility, when everyone is clueless and chaos reigns supreme.
Is it a good idea to trade with decentralized finance, even during a market crash? Yes! Your success in crypto trading completely depends on your tactics and how clever you are. A well-planned trading strategy and a deep understanding of the crypto markets can make a difference. Check out this article on Is This The Right Time For Crypto Trading to make your decisions better.
Which is better: Decentralized VS Traditional Finance Trading?
Both the traditional and decentralized finance markets share some characteristics, but they couldn’t have a more different risk-reward dynamic. If you are looking for a smooth, fairly predictable market with higher liquidity that rewards patience, then forex should be your choice. But if you enjoy a higher risk appetite and are looking forward to seizing longer trends and higher volatile prices, then trading cryptocurrencies will suit you better. Consider talking to a financial advisor about investing in forex and crypto markets, and remember never to trade in any market with money that you are not willing to lose. Risk management is an essential element for investment in any market.
Even though crypto assets, including cryptocurrencies and NFTs, gave young investors the chance to make lots of money faster, you should only invest what you are prepared to lose and stick to more conventional investments for building wealth over the long term. Instead of learning how to navigate a cryptocurrency exchange to trade your digital assets, you can add crypto to your portfolio by adding it to the brokerage with which you already have a retirement or other traditional investment account.
Technological innovation also has facilitated the development of apps and services to meet the needs of Gen Z traders seeking exposure to the digital world. As appetite for traditional investments is decreasing because of outdated approaches or trust issues, young investors have turned to alternative investments including the crypto market. Gen Z members prefer to do their own research rather than relying on insights from traditional financial advisors. Know how the Millennials and Gen Z Invest in detail here.
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Before venturing into the investment world, the first and foremost step is to ensure you understand the risks you are taking on. It is advisable to meticulously weigh the pros and cons of a potential investment and see whether it is in line with your investment objectives, risk tolerance, and financial goals. If you want to invest your first funds in Forex, you need to start with a brokerage company that offers secure accounts and reliable trading conditions. This is where AximTrade stands out. Check out the AximTrade review.
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AximTrade offers comprehensive brokerage services on global markets with MT4 execution and Copy Trade platforms. In addition to Forex, AximTrade also offers crypto traders and crypto enthusiasts some of the best investment opportunities by offering 35+ major crypto pairs including BTCUSD, LTCUSD, and ETHUSD. The platform also offers over 72 stocks and a variety of financial assets for beginners and professionals to access the market. Detailed instructions will be provided on how to open a forex account, outlining everything from the benefits to the terms. Happy Investing!
