Despite a purported divide between traditional finance and decentralized finance (DeFi), both paradigms could benefit global finance through mutual cooperation, according to a white paper from ING.
The white paper begins by defining decentralized finance. It defines it as “the transformation of traditional financial products into products that operate without an intermediary via smart contracts on a blockchain.” It suggests that any centralized financial service could potentially be transferred into a decentralized one.
Because of DeFi’s supposed potential to overtake traditional banking, the white paper suggests there is a growing divide between them. However, after describing several components of DeFi, the report offers a few lessons on how they may actually complement one another.
Lessons from DeFi
First of all DeFi offers composability, defined as “the ability to build a complex, multi-component financial system on top of crypto-assets.” Using open-sourcing, developers can easily connect and re-use existing components on the blockchain to create new financial services.
The white paper suggests that corporate institutions could consider open sourcing their services, to offer readily adaptable new services.
Additionally, DeFi enables global transactions at a much faster rate than centralized financial institutions. Currently, this efficiency comes at the cost of added complexity for the user, according to the report. However, the decentralized aspect of the technology simplifies a separate aspect of cross-border payments.
By utilizing distributed ledgers, DeFi ostensibly enables efficient payments across different geographies and jurisdictions. Through integrating these aspects, traditional finance would have much to gain.
Benefits of traditional finance
However, DeFi also comes with its own flaws that traditional finance could help to rectify. For instance, at this stage it is still unclear where liability lies if a DeFi protocol doesn’t work as intended. Similarly, the report highlighted the biased nature of DeFi literature, which seem reluctant to address risk.
As traditional financial institutions specialize in identifying liability and mitigating the associated risks, DeFi could benefit from this expertise, the report says. This would also be the case in terms of KYC and AML compliance.
Finally, as DeFi develops, it aims to further integrate with the physical world. The report distinguished between digital tokens and digital assets. The former only exists digitally, while the later may have counterparts in the real world.
For example, an NFT deed and the physical house it corresponds to in the real world. DeFi is currently focusing on the tokenization of assets, the real world realization of which could also benefit from traditional expertise.
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