In this article, we take a look DeFi vs. FinTech, what they are, their pros and cons, and at what point the two methods deviate. This is an important conversation, as global FinTech investments have increased more than 2,200% between 2008 and 2015, skyrocketing from $930 million to more than $22 billion.
In many ways, both FinTech and DeFi are aiming at the same thing; improved access to financial services. Moreover, both industries participate in the increasing efforts to make financial dealings more accessible, error resistant and efficient. There are just a few differences that need to be made clear, as DeFi is going about this in an unconventional way.
The major difference between DeFi and FinTech is that specific companies and applications use these formats to achieve these their respective goals. DeFi, or decentralized finance, relies on decentralized operations which use open source systems. The broader world of FinTech includes some DeFi, however, it implies that there is some kind of central authority in effect.
The internet’s design has essentially become a decentralized system with no particular owner. Rather many services operate within its communal digital space. Wiki and Wikipedia are examples of how open source platforms are estimating access limitations to valuable information. And smartphones and social media platforms have contributed to the decentralization of many consumer needs and new media sources.
As I mentioned, a lot of businesses fall under the umbrella of FinTech, including DeFi applications. Fintech is any financial technology that is competing with and trying to improve upon traditional financial methods and services. Included in the realm of FinTech is the use of smartphones for traditional banking, as well as services specific to cryptocurrencies.
Now, before anyone gets all excited, many crypto-platforms use a combination of centralized and decentralized control. Companies like Coinbase, for example, deal in cryptocurrency. But the actual company is centrally organized. One of the challenges that all financial industries face is balancing the two; how much is the right about of control? Or is it better to be totally decentralized? The jury is still out. So, let’s go through a few of the nuances of FinTech and DeFi.
If you want to know who some of the major FinTech players are, then check out Forbes 50 FinTech.
Decentralized Financial Application
DeFi specifically refers to decentralized financial applications but falls under the broader FinTech umbrella. DeFi applications include lending protocols, security tokens, derivatives, and exchanges, to name a few. Ethereum’s decentralized platform broke ground on DeFi. Ethereum now powers the development of many independent decentralized applications.
Decentralized finance has several features that distinguish themselves from the over-abundance of FinTech apps:
- These applications are obviously decentralized and rely primarily on smart-contract.
- Self-execution of smart-contracts has provided a trustless system. It relies on the program to execute tasks if and when the stipulations are met.
- Using consensus algorithms, these applications limit the need for bureaucracy.
There are, for obvious regulatory reasons, fewer limitations as to what can be built on a decentralized platform. DeFi does not need to function within an existing bureaucratic framework. The bureaucratic organization takes place at the basic level of the application development, rather than rely on heavy higher up management.
The real genius is that by using a platform like Ethereum’s, anyone with internet access can create something; there are no licenses or regulations that need to be navigated.
Proponents of DeFi are jazzed by the new level of accessibility these apps allow. By building a financial application on open source platforms, a whole new market has opened up. Auger is an application used to trade cryptocurrency. It is a peer-to-peer oracle prediction market protocol built on Ethereum. This app, like others, makes a more diversified demographic of participation possible.
Here is a short list of DeFi applications.
Arguably, some of the greatest challenges that FinTech faces are security and compliance with the regulations of various government institutions. Securing data and privacy of information is an increasing concern between users and providers, especially when networks are not secured.
Still, X-Road is a great example of an open source data exchange. X-Road’s platforms are centrally managed which has advantageous qualities. Estonia uses X-Road to manage its e-bureaucracy. Citizens can access medical records and vote because of the implementation of e-citizenship.
There are clearly many advantages to open source data and decentralized networks. However, there are many circumstances that we can imagine where relying on centralized control would potentially provide more security. This might be the case for medical records and other private citizen information, at least until some of the kinks in the system have been dealt with.
If you take a look at the chart below, you can see that DeFi is offering solutions a revolutionary way that even FinTech is not capable of.
Limitations of Decentralization
While DeFi opens doors for new markets and has greater accessibility, it still suffers from several limitations. The first is that it is unclear whether or not decentralization is always a good thing. We are in the early phases and for now we are relying on beneficent users. This does not stop anyone from building platforms to perform nefarious activities. Moreover, scalability is still a major issue. Dealing with the increasing demand is a challenge that has yet to be solved completely.
One of the draws of decentralization is transparency. Rightfully so, investors are tired of having their own valuable data and information kept from them. However, at this point in decentralization’s infancy, we still rely on many centralized financial institutions.
Exchanges like Coinbase, which coordinate wallets and transfers are centrally managed; perhaps as a necessity, at least for now. Also, many crypto projects are organized and controlled centrally. This limits transparency and accountability.
The inspiration behind decentralized systems is a move to allow users more control while reducing upper management costs. FinTech operations rely on the inherited 3rd party trust traditional institutions have assumed. So not only are there many legalities and formalities for participants to navigate, but these systems also work as gatekeepers for many and make markets, products, and services inaccessible.
DeFi, on the other hand, applies blockchain technology and cryptographic security to build trustless systems that run on the logic of algorithms. The automation of Ethereum-based smart-contracts is central to limiting the prodigious bloat of bureaucracy.