What Is TradFi?
TradFi stands for “traditional finance”. It refers to the age-old practice of managing money or assets through institutions such as insurance companies, stock markets, banks, real estate funds, and asset managers. For example, mortgages, savings accounts, foreign exchange services, and bank loans all operate under the umbrella of traditional finance.
Centralized structures characterize the foundation of traditional finance. As such, any financial entity strictly regulated and operating under a central authority’s (government) guidelines is a traditional finance service or product. The people trust the central authority to safeguard and manage assets and risks on their behalf.
The term is often used relative to decentralized finance (DeFi), which underscores financial services and applications operating on a blockchain and independently of any central governing body. DeFi proponents perceive it as the potential replacement for traditional financial systems and institutions.
TradFi vs DeFi
A clear distinction between these two is that one is centralized and the other decentralized. While DeFi facilitates decentralized services between a user and a smart contract, traditional finance interactions are between the user and a central authority. For rendering their services, traditional financial institutions charge high transaction costs. DeFi systems, conversely, automate the roles entities in conventional transactions play to reduce the overall transaction fees.
DeFi also opens up financial services and products to anyone, lowering the entry barriers and promoting innovation. Furthermore, traditional finance primarily uses fiat currencies, while DeFi is designed around digital assets that facilitate payments and borrowing/lending services.
Another important difference is that traditional finance is subject to strict regulatory and compliance requirements. For instance, conventional financial institutions must adhere to know-your-customer (KYC) guidelines. The strict regulation rules cushion users against fraudulent activities and losses. Contrary to that, DeFi is inherently unregulated. For this reason, financial scams riddle the DeFi ecosystem.