DeFi vs. Traditional Finance: The Impact of Decentralization on the Financial System

FINANCE AND BANKING / by Miguel Gallardo Guerra

The emergence of virtual assets and user empowerment through Decentralized Finance (hereinafter, “DeFi”) have driven a transition to a decentralized model in global banking systems. This change represents a fundamental evolution in the provision of financial services.

What is Decentralized Finance?

Unlike traditional finance(hereinafter, “TradFi”), DeFi is characterized by a system in which operation, administration, and security are distributed among participants using blockchain technology. This eliminates the need for intermediaries, reduces costs, speeds up transaction times, and allows the parties to carry out operations directly and autonomously.

DeFi Main Elements

DeFi operates through specific tools and mechanisms, which allow the creation of a decentralized financial system, such as:

1. Self-managed wallets: Users act as custodians of their assets, storing them in digital wallets controlled by them.
2. Smart contracts: Programs that manage digital assets and ensure the execution of agreements transparently and securely.
3. Staking contracts: They allow to receive rewards by blocking cryptocurrencies in wallets, depending on the deposited values and the agreed conditions.
4. Exchange protocols (DEX): Platforms such as Uniswap facilitate transactions through smart contracts, allowing assets to be used as collateral or exchanged for other assets.
5. Structures similar to securitization: Tokens representing underlying assets are issued and can be traded in secondary markets.

Traditional DeFi vs. Institutional DeFi

Traditional DeFi is based entirely on blockchain technology, where asset custody, identification processes, and applicable regulations are essential. In this model, users are responsible for their funds and operations without requiring the involvement of an intermediary. On the other hand, Institutional DeFi adopts decentralized structures within the framework of traditional financial institutions, through which, by integrating blockchain, financial institutions maintain their role as intermediaries but adopt a more agile, secure, and accurate infrastructure.

This model allows financial institutions to leverage the strength and resources of traditional banking with the agility, security, and accuracy of blockchain technology. From the legal point of view, Institutional DeFi opens opportunities for:

• democratizing financial services through the tokenization of real assets;
• creating more efficient business models, and
• reducing costs and offering more accessible products.

Advantages and Legal Challenges of Institutional DeFi

Decentralization at DeFi disperses power and risk, in contrast to centralized systems, where financial institutions assume responsibility for ensuring the safety of assets. This approach presents legal and regulatory challenges, such as the lack of global standards and the risks inherent in the technology.

Despite these risks, DeFi promises financial services accessible to anyone with an Internet connection, operating continuously, without traditional banking hours. This model can transform financial access for millions of unbanked people worldwide, offering a unique opportunity to foster global financial inclusion.

Comparison: Traditional Finance vs. DeFi

Problem/Characteristic	TradFi	DeFi
Cost per transaction	High due to the number of intermediaries.	Low, due to the absence of intermediaries.
Speed per transaction	Slow and restricted to banking hours.	High, even immediate, incentive-based blockchain.
Accessibility	Restricted, subject to pre-qualification and banking requirements.	Broad, as anyone with an Internet connection and a wallet can access it.
Control over money/assets	Controlled by financial entities.	Total control by users over their funds.
Product interoperability	Limited, with complications in integrating products.	High, with easily integrated products, with the help of smart contracts.
Transparency	Low with limited traceability.	High, due to the nature of blockchain technology.
Use of personal information	It requires complete identification.	It can be null or managed according to designed structures.
Chargebacks	Common through reversible processes and possible disputes.	Nonexistent due to their technical nature.

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