65. What is TradFi? The importance for cryptocurrencies!
Literally translated – traditional finance. It is the familiar old-school financial system. It consists of intermediaries such as banks, financial institutions, market makers or the stock and bond market. The whole system works with fiduciary money and traditional assets, which include securities, commodities and real estate.
In previous lessons, we have talked about DeFi. It is now time to take a closer look at this financial ecosystem. Enjoy your reading!
TradFi – definition
TradFi, commonly referred to as traditional finance. It is a entire financial ecosystem, unrelated to cryptocurrencies and decentralised finance. We interact with it in our daily lives. The financial systems and institutions that are part of TradFi have existed for decades. They include:
- Insurance companies.
- Savings accounts.
- Bank loans.
- Foreign exchange services that are performed by retail, investment or commercial banks.
- All other regulated financial entities.
Each of the above components of TradFi operates under strict guidelines from the government of the country concerned.
In the digital asset ecosystem, the term “TradFi” is often used to distinguish traditional finance from its decentralised form (DeFi). It is worth knowing that traditional finance encompasses the largest markets in the world, including the foreign exchange market (Forex).
We tend to think of TradFi as centralised finance, for which the barrier to entry is much higher, compared to its decentralised form. Traditional finance will not offer us fully decentralised services, based on intelligent contracts and open to everyone.
The ecosystem discussed today is also frequently compared to CeFi (centralised finance). Admittedly, CeFi offers many services similar to decentralised finance, but its users access services through centralised exchanges. CeFi also has some similarities with TradFi. For example, even the way in which users get access to products – they too have to set up accounts with suppliers and hand over custody of assets to them.
How does traditional finance (TradFi) work?
TradFi is still fully centralised, despite the fact that it uses many digital solutions. Transactions or loans are still controlled by the relevant entities and services.
In the TradFi ecosystem, you will not find Peer-to-Peer transactions, but intermediaries that users must trust and entrust control of their money and assets to. Worst of all, any TradFi institution or intermediaries must operate with rules dictated by governments. Third-party oversight is the worst disadvantage of TradFi.
TradFi and cryptocurrencies
When the first cryptocurrencies and blockchain technology emerged, black clouds began to gather over traditional finance. This modern technology has opened up new possibilities for finance, providing greater financial inclusion for third parties and entire communities. With cryptocurrencies and blockchain, people no longer need to put their money in the hands of third parties – they have full power over it.
With the subject of TradFi, one important question often arises – will DeFi replace TradFi? The answer is not clear-cut. Traditional finance still dominates, especially in terms of its size and financial impact. They are certainly not going away any time soon. There are as many proponents of decentralised finance as there are of traditional finance in the world. TradFi satisfies the needs of many users and a variety of businesses. For many, it is stability and security that they will not swap for a decentralised form.
Clearly, decentralised finance (DeFi) is growing in popularity every year. They are a potential replacement for the financial systems we are familiar with and, no doubt, will have a significant impact on the sector as they develop.
How is traditional finance (TradFi) regulated?
Mainly by a country’s government and central banks. Each TradFi institution must comply with the rules and regulations set out for it by the authority. It is also obliged to submit annual reports on audits conducted internally. Bureaucracy and strict regulations are another downside of TradFi, although it is these two factors that help to reduce money laundering, corruption or other illegal activities.
Advantages of TradFi
First of all, only selected entities can provide services in the traditional finance sector. They need the appropriate licences and accreditations to do so. All this bureaucracy is supposed to make it more difficult for fraudsters to operate and eliminate and from the TradFi market.
Secondly, TradFi by cooperating with central authorities, it can trace illegal activities more easily. In decentralised finance (DeFi) this is more difficult, due to anonymous transactions. However – it is not impossible.
Disadvantages of TradFi
Constantly changing regulations and legislation are an obstacle to growth and innovation in this sector. Because of these restrictions, a large number of users are unable to access TradFi’s financial services. A good example of this is bank loans, which not everyone can afford.
In an ideal world, blockchain, cryptocurrencies and TradFi should join forces. We would witness the creation of financial infrastructure, designed for everyone. Will this happen? Time will tell.
At this point, this TradFi is ubiquitous. It is the site of our daily transactions. CeFi and DeFi are the doors to a new world and opportunities that still have a long way to go before mass adoption.