DeFi Vs Traditional finance: Old problems solved and new ones created

Decentralised finance has been one of the hottest topics in encryption this year. Although activity and volume in the DeFi space still lag behind its current fever, this is changing with the emergence of new protocols. In fact, according to a recent report by Talsys, the software company responsible for blockchain, the number of locked ETH and active users on The DeFi platform has shot up this year after stagnating for a period, according to Talsys.

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DeFi tokens have also been a hot topic as they have outperformed Bitcoin in price performance for several weeks in a row. Rhythmic has learned that Compound governance COMP tokens jumped 233% in their first week of trading, while Aave LEND has soared 1,000% over the past three months. Therefore, there is an obvious comparison between decentralized finance and centralized finance. Centralized and decentralized systems have their pros and cons, so even with the rise of DeFi, both types of financial products and services are likely to remain public forever.

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Here's a detailed look at some of the advantages, disadvantages, challenges, and problems associated with centralization and decentralization in the financial world. The emphasis below will be particularly on decentralized lending, one of DeFi's most popular applications for volume/value locking today, which in a sense has sparked hype around the larger concept of DeFi.

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What is DeFi and traditional finance?

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DeFi is a set of blockchain-based financial services and products that mimic the services people have become accustomed to in traditional finance, but without a centralized party (such as a bank) to provide those services. Instead, these services are provided by other users,They act as financial counterparties, with no middlemen involved.

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These financial products range from popular credit and lending services and decentralized trading platforms to stabilizers, insurance, payments and hosting services, but most importantly, this is the first application that drives DeFi's popularity. According to Rhythm, Jon Jordan, director of communications at DappRadar, the DeFi protocol has the ability to learn, adapt and grow from each other, which is one of the reasons decentralized finance is evolving so fast. Companies like MakerDAO, Aave and Compound offer the same lending services that traditional Banks do, but with potential advantages and disadvantages. These lending services are similar, even to the centralised services they mimic; However, the inner workings of each project are often very different from traditional services.

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DeFi runs without a centralized mechanism?

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There are different types of lending and credit platforms in the DeFi space, most of which use the Ethereum blockchain. These projects adopt different strategies, allowing users to borrow from each other without the involvement of a central entity. This means that you don't need to know your client's identity or everything. It reduces bureaucracy and controls, but it still ensures that lenders and their funds are secure.

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Rhythm learned that Aave USES a liquidity pool strategy where lenders provide liquidity by depositing ETH or ERC-20 scrip into the pool. Not only is it possible to earn interest, but you can even use the money you deposit as collateral for a loan. Thus, users can obtain short-term credit lines in stabilizers or other tokens without having to liquidate their assets.

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MakerDAO, on the other hand, allows users to obtain their Dai stability currency by locking their OWN ETH, although users will need to deposit more Ether COINS than they can withdraw, and their withdrawal rates will vary. This enables MakerDAO to maintain Dai's peg to the dollar because it is backed by more than its worth by the ETH, which in turn protects the agreement from ETH price volatility.

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Finally, the Compound adopted a similar model to Aave, but with a unique incentive structure that led to the creation of liquidity mining, where the governance token COMP was awarded to lenders and borrowers at a given interest rate. At the same time, the value of token money COMP also increased.

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The DeFi protocol's interest rates vary, some in the double digits, while Banks typically pay less than 1% when they deposit money. In addition, although traditional finance requires information and credit scores, it also allows for different types of mortgage, especially with different assets, such as houses. However, in theory, scribing could soon change that, as the scrip of securities representing the property or part of the property would be introduced into the DeFi protocol.

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KYC rules, anti-money laundering, privacy and accessibility

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Since DeFi users can access financial services without KYC and identity documents, the sector opens up a wide area for emerging economies. As of 2017, there were still 1.7 billion adults worldwide without a bank account, according to Global Findex. Although the less developed countries will benefit most from DeFi, there are also many unbanked or underbanked people in the developed countries.

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However, while DeFi's open policy has its advantages, it also means that illicit funds can flow through the platform without any anti-money laundering measures. Given this, regulation could soon become one of the biggest challenges in the DeFi space.

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In terms of convenience, DeFi has made it easy for users, and although the user requirements require a certain amount of knowledge, the platform is open to anyone willing to join. Opening a bank account, on the other hand, requires no equipment or prior knowledge; But even so, many are unable to do so because of information problems or the inability to qualify for products such as loans. In some extreme cases, people can't even go to a physical bank, which is necessary to open an account.

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Safety and centralization

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So how does the DeFi platform stack up against traditional finance in terms of security? There are many questions to consider in answering this question. Banks can be hacked, but because transactions can be cancelled and reversed, this usually leads only to the disclosure of private financial information, which is, of course, quite harmful to the people affected. In DeFi, since all transactions are recorded on the blockchain and all information is already public, this information is generally harmless given the pseudonyms used.

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Speaking of DeFi, there is a thin line between security and decentralization. Protocols like Aave and MakerDAO are theoretically immune to hacking because they do not rely on centralized servers as a single attack vector, but on distributed nodes that cannot be affected without an attacker doing 51 percent of the attack on Eethernet.

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However, the underlying blockchain created by these protocols is not the only thing to note. Unlike Banks, no one can freeze or reverse trades if an account goes wrong. Ultimately, if not properly audited, the code for the above protocol may be defective and cause vulnerabilities. & have spent As with The infamous project The Dao, Balancer was recently hacked, losing more than $500,000, and $25 million stolen from dForce, although The hackers have since returned The money.

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Scalability, availability, and mobility

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Rhythm understands that although the above project has been launched, there are still some limitations in terms of availability. For example, most platforms are not translated into multiple languages, which may make them difficult to access and use by users in different regions, and these DeFi platforms require a certain level of technical knowledge that some people simply cannot acquire or learn systematically. In addition, these DeFi protocols also require an Ethereum wallet and some tokens, which are usually available through some form of banking. Therefore, currently DeFi is not as easy to operate in practice as it is in theory.

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In terms of liquidity, there is no doubt that traditional finance is king. DeFi is a novel concept, so it is not very popular outside of encryption. This means that there is little liquidity in these projects. Compound recently reached a key borrowing milestone of more than $1 billion, and currently has about $1.6 billion in locked up funds. Aave also has more than $200 million locked up. Although DeFi is making progress, it is not comparable to the scale of traditional finance. And a lack of liquidity naturally makes it harder for users to get interest on loans or specific assets.

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In addition, ethereum's current congestion and scalability issues may soon start to hinder the use of DeFi. If the network becomes congested, the fees become very high and transactions take a long time to process. Rhythm understands that while there is a second layer of solutions, Ethereum 2.0 is still years away from being fully developed and implemented. In addition, the lack of scalability can lead to problems in the future, which can be dangerous for DeFi projects and users.

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conclusion

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As mentioned above, both systems have advantages and disadvantages. While some of these issues, such as liquidity and scalability, can be addressed by DeFi, there are inherent problems, including the lack of KYC and dispute resolution procedures, which can only be mediated between the parties through centralized entities.

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Can DeFi move beyond traditional financial models in the future? More likely than one replacing the other, the two concepts will coexist and serve different needs and customer groups, and compatibility with traditional financial systems is likely to be DeFi's next major milestone.

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Text link:https://cointelegraph.com/news

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