Financial decentralization: Can DeFi replace traditional finance?

Luo Tao, Chief Compliance Advisor of Global Blockchain Compliance Alliance, lawyer of Taihetai (Beijing) Law Firm, [email protected]

Over the centuries, intermediaries have played a vital role in reducing transaction costs and expanding transactions, helping both parties to establish trust, negotiate contracts, and finally conclude transactions. However, this powerful power has also triggered a monopoly on intermediaries Status concerns. This tension is particularly prominent in the financial sector, where large financial institutions often control the lifeblood of financial transactions.

With the rise of digital technologies such as blockchain, distributed trust mechanisms and decentralized platform features cater to people's transaction expectations, reduce the need for intermediaries, and make financial services more decentralized, innovative, borderless, and transparent. DeFi (Decentralized Finance), a decentralized financial model, came into being. Defi built a brand new ecosystem independent of the traditional financial system, to a certain extent, to make up for the shortcomings of traditional finance:

First, high transparency and reliable trust mechanism. The non-tamperable modification of the blockchain technology guarantees the authenticity and reliability of the trader's transaction information, which in turn generates distributed trust. Both parties to the transaction can transact with each other without a pre-existing relationship or trusted intermediary, avoiding traditional Under the financial model, information access is restricted and information is falsified, reducing the risk of trust.

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Second, reduce transaction costs and increase transaction efficiency. Decentralized and de-intermediate blockchain technology can reduce the costs associated with searching, signing, and executing on both sides of the transaction. At the same time, the borderless nature of decentralized finance is more conducive to the global transfer of value, just as convenient as sending emails.

Third, expand the scale of transactions. By reducing the participation of central agencies and reducing the possibility of a single entity generating monopoly power, so that everyone can benefit from the network effect to expand the scale of transactions.

Fourth, enhance interoperability. Traditional finance tends to be independent, increasing transaction barriers between different financial institutions. Decentralized finance is built on public blockchains and open standards, thereby improving the interoperability of different service platforms.

DeFi's application areas involve encrypted asset lending, encrypted support loans, token leasing services, and blockchain-based bank operators. It can be said that DeFi already has the basic core functions of traditional financial institutions. It has become an irreversible trend in the traditional financial industry, and it has shaken the dominant position of the traditional financial model. However, it is not realistic for DeFi to replace the traditional financial model in the short term.

1. Complete decentralization is difficult to achieve

The traditional financial model has its inherent cultural core. It has experienced historical scour and power constraints and balances. Traditional finance has formed a complete transaction process and risk management model, which has been accepted by inherent trading habits. Rapid updating is not realistic.

In contrast to the current status of decentralized platform operations at this stage, large trading platforms including Huobi and Binance still need to rely on centralized management and control, and their transaction volume also exceeds that of fully decentralized trading platforms (DEX) Many orders of magnitude. In fact, many DEXs are not decentralized in the true sense. Human governance is still needed. Under the circumstances of being mainly driven by profits and lacking the power of all parties, the risk of complete decentralization is even more difficult to predict.

2. Limited technical development

DeFi is built on the underlying public chain, and the underlying technical level determines the application dimension of DeFi. Currently, network performance, including the Ethereum network, has encountered bottlenecks, and the development of technology has not been achieved overnight, which has hindered the development of DeFi to a certain extent.

DeFi's development at this stage is also immature. Although it has the core functions of traditional financial institutions, its products are relatively simple and the application rate is low. To break through the traditional financial framework is not simply to achieve functional replacement.

3. The application of traditional financial commodities is blocked

To realize the wide application of DeFi will inevitably cover traditional financial products, and this puts forward higher requirements for the application of traditional financial products, and it is necessary to increase the technical added value of the products, which undoubtedly increases the cost of product development.

4. Limited audience

Technology also limits the audience of DeFi. Although the number of currency holders is growing rapidly and the size cannot be underestimated, compared with the entire financial market, the anchored population is still a small number, and the user's operational requirements and technical understanding capabilities are required. Very high, so that some groups are isolated.

5. Unknown security

This week, Bisq, a decentralized exchange that allows users to trade encrypted assets anonymously, was hacked and the amount of theft amounted to US $ 250,000. To avoid greater losses, platform developers shut down the platform. Although this is a good thing for investors, it also raises concerns about the security of cryptocurrencies and whether the platform has sufficient capacity to resist systemic risks.

Under the DeFi model, the financial business and functions are relatively single, and there is a lack of understanding of financial risks. Without the support of traditional financial institutions, the targets can be attacked more clearly, and their ability to control risks is relatively weak.

At the same time, since the outbreak of the new crown virus, the Black Swan incident has occurred frequently, and any huge fluctuations in the currency price may be a fatal blow to DeFi under a single structure. As the scale of DeFi continues to expand, the cascading effects of systemic risks are increasing.

It can be seen that the development conditions of DeFi are not mature at this stage, and it is difficult to cause the imaginary dimensionality reduction blow to traditional finance. But to put it another way, if we focus on the technical services provided by DeFi, it is not difficult to find that the two are not in the state of "I am without you". The technology and innovative functions contributed by DeFi can be compared with traditional finance. Integration will further expand the scope of future fintech applications.

The emergence of any new model will face obstacles. It should neither be over-exclusive nor idealistic. Finding a meeting point between the two parties may bring more surprises. In the future, DeFi's development is irreversible, but if it is to be implemented, it is necessary to embrace traditional finance and strive to find the intersection of the centralized and decentralized financial worlds. The two can penetrate each other to achieve a win-win situation.

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