Crypto 101: drawing a parallel between DeFi and TradFi

If you just read the headlines, you would be forgiven for thinking that crypto is unsafe, a scam, or a mixture of the above. Perhaps it’s the volatility that catches your eye — how it makes people rich one day, and wipes them out the next. Or, maybe Elon Musk said something about a memecoin.

Either way, the misconceptions of crypto have been borne from thorough examinations of the “dark side” of Decentralised Finance (DeFi). But, look a little deeper, and you’ll find something extraordinary happening: crypto and the DeFi ecosystem are increasingly mirroring the traditional financial (TradFi) system. 

HODL your investments

The mantra of crypto enthusiasts worldwide — to hold on for dear life (HODL) — is indicative of the application for which crypto is currently best known: as an investment. 

As the “currency” part of cryptocurrency is still lacking in mainstream use, with many jurisdictions and governments reluctant to adopt it, investing has become the core use case. In some instances, such as the recent collapse of Luna, to its detriment as well. 

Crypto investing is now big business. There are an estimated 106 million participants globally investing through crypto exchanges. In the US, it is reported that one in five have invested. 

This figure is growing, as is the amount invested. According to a major survey of 28,615 retail and institutional investors we conducted for crypto exchange Bitstamp, 73% of retail participants are even planning to increase their investments in crypto, with the major use cases reporting to be purchasing another form of crypto, and peer-to-peer payments and transfers — showing utility beyond HODLing. 

It’s that utility that is attracting greater entry from institutions and the largest financial players in the world — and creating a new environment for crypto.

Introducing crypto banking 

The underlying technology behind crypto — blockchain — is already seeing a revolution in banking operations. 

The blockchain is effectively a digital ledger, maintained by a network of computers, that records all transactions. Users mine blockchains by solving complicated mathematical puzzles, and are rewarded with a token — a cryptocurrency. 

But it’s the ledger part that is currently attracting TradFi. It can digitise the entire trade finance lifecycle with increased security and efficiency. It can enable more transparent governance, decreased processing times, lower capital requirements and reduced risks of fraud, human error, and risks on the other side of the financial transaction. Banking will eventually be run on the blockchain.

Looking beyond the banking back office, crypto and DeFi more generally, is also changing the face of banking. 

The traditional financial ecosystem — including the largest banks, investment houses right through to new neobanks and superapps — has evolved over the centuries to provide use cases and products to help make your money become more money. These same principles can be applied to DeFi.

A case in point — while many financial institutions are looking at adopting or have adopted some form of crypto capability, the most forward facing ones are looking at applying existing frameworks onto crypto. This can be seen in increasing use of crypto derivatives. This is similar to the traditional form of derivatives; whereby a buyer and seller enter into a contract to sell an underlying asset, which is sold at a predetermined time and price. But instead of a bond or commodity such as gold or oil, it’s Bitcoin or Ethereum. 

The convergence between DeFi and TradFi is already happening. If the financial sector can find a way to overcome the scalability and regulatory issues, then we can see mainstream use cases occur quickly. 

Staking your claim

This isn’t to say that the use cases are limited to just investing or peer-to-peer payments for the moment. The DeFi ecosystem is already creating and defining products to increase utility. One major product available to many via crypto exchanges right now is the ability to “stake” your crypto to earn interest. 

Staking is available on some crypto blockchains, due to the nature and use case of the technology underpinning it. Investors in Ethereum, for example, can stake some of their holdings to earn a percentage-rate reward over time — with the benefit for the blockchain being that it can put your crypto to work. This often happens through a “staking pool,” itself being similar to an interest-bearing savings account. A consensus mechanism called Proof of Stake ensures the validity of the transaction, without requiring a bank to act as an intermediary or payment processor in the middle. 

Until recently, this was a complicated process requiring a significant amount to be staked and a good degree of technical knowledge. But — as the banks before them — crypto exchanges are looking to further productise the DeFi ecosystem, and lessen the barriers to entry. 

As the sector matures, we should expect more products to rise to the surface.

Tokenised creativity

It would be remiss to discuss DeFi and not give mention to Non-Fungible Tokens (NFTs). 

NFTs are unique cryptographic tokens that exist on a blockchain, which means they cannot be replicated, and can be digital-only works, or represent real-world items like artwork and real estate. “Tokenizing” these real-world tangible assets makes buying, selling, and trading them more efficient while reducing the probability of fraud.

To date, the use cases have seen mixed results, with many NFTs being essentially, customisable digital “art” — such as the much hyped Bored Ape. But there are interesting opportunities, especially for creators and artists. 

In essence, NFTs give artists a way to sell their work where otherwise there might not be much of a market for it. This is especially true for digital artists, but also for musicians to make money off their work directly to their audience. Moreover, NFTs feature the ability to be paid a percentage cut every time the work is sold or changes hands — so as the work becomes more popular, more revenue can be generated from it. 

For buyers, NFTs grant some usage rights — such as being able to publicly post the image online if it’s a digital artwork. This is also recorded on the blockchain, so it is immutably yours. It also works as a speculative asset, so can be treated as another investment type. 

The use cases are there, but the market is still immature. NFTs also have significant reputational problems to overcome, with the market saturated with NFT scams.

The future: DeFi or TradFi?

Currently, it looks as though the two systems are worlds apart, even competing. But a convergence is underway — with the two learning from each other, and productising offerings based on the capabilities and use cases of the other. So, the future won’t be either/or. It will be TradFi and DeFi — fully integrated into one financial system. 

How do we know this? Because we live and breathe crypto and fintech. If you’re a web3 disruptor, DeFi or crypto innovator, or fintech looking to evolve financial systems, we can help. From ideating and executing major, global creative campaigns to growing your reputation and share of voice, we’re ready to collaborate with you. Get in touch.

Rich Went
Rich Went
A senior account director at Gallium, Rich is a news junkie with a passion for everything music, fintech and web3 with a decade's worth of experience in PR, comms and marketing.