DeFi is a subset of fintech, but as time passes, it's an increasingly large subset. Find out how decentralized finance interacts with fintech.
After reading this, you'll understand:
Fintech services are built around trust and third-party intermediaries.
DeFi could provide cost savings for fintech companies by automating many of their procedures.
Fintech companies require a network with low fees and high throughput.
The global financial system is becoming increasingly reliant on technology, leading to an uptick in new financial software, mobile applications, and websites. Technologies like these are known as fintech (financial technology). Fintech and DeFi (decentralized finance) are often conflated, as they both use technology for financial services.
Although the two concepts are similar, they're fundamentally different. All DeFi applications are considered fintech, but not all fintech is considered DeFi. In this article, we'll take a closer look at fintech vs DeFi.
The phrase "fintech" refers to technologies designed to improve the financial system. This includes online banking solutions, mobile payment applications, investment software, and other technologies used for financial services. For example, services like PayPal let you send money to friends or businesses without exposing your bank account details. You can receive payments from others or use the built-in PayPal payment system on e-commerce websites to pay for goods and services. Similarly, Cash App and Venmo are popular mobile applications that let you send and receive money by linking your bank account or debit card. Other popular fintech applications include Robinhood, Stripe, Square, and Coinbase.
Fintech has become popular over the years. According to Forbes, Americans spend around $13 billion annually on monthly subscriptions for fintech services. Many people rely on these applications to keep track of their finances and make smart purchasing decisions. For others, financial applications offer a convenient way to access their money.
Like most aspects of the traditional financial system, fintech services are built around trust. When using these financial products, you must trust that they have safeguards to prevent your bank account information from being leaked. They also require the use of intermediaries. For example, when you checkout on an e-commerce website using your PayPal account, you trust PayPal to act as the intermediary for that transaction.
The decentralized finance system lets people access financial products without the need for an intermediary. DeFi applications are built with distributed ledger technology and smart contracts, automating most of their features and eliminating the need for trust. In most cases, DeFi apps let people buy, sell, or transfer digital assets. Still, over the years, numerous DeFi applications have emerged, letting people do many of the same things they can do with traditional financial products. For example, you can use DeFi apps to take out a peer-to-peer loan, start a savings account, or day trade speculative assets.
Uniswap, for instance, is a popular DeFi protocol that uses an automated market-maker system to let people buy and sell cryptocurrencies. When someone buys a cryptocurrency, they effectively remove a certain amount of that token from the liquidity pool while simultaneously adding another token. The application uses smart contracts to facilitate the transfer of these tokens, and the ratio of each token is what determines the price. This system lets it facilitate trades without the need for an intermediary. PancakeSwap and SaucerSwap use a similar technology to facilitate decentralized trading on the Binance and Hedera networks, respectively.
DeFi platforms are perfect for those seeking privacy and enhanced security. They let you carry out anonymous financial transactions secured by advanced cryptography. DeFi is also ideal for those seeking affordable borderless transactions, as the lack of intermediaries often means fewer fees. Decentralized finance and digital assets can also be a great way for the unbanked to start a savings or transact with others online.
However, DeFi isn't without risk. The anonymous nature of decentralized finance makes it easier for bad actors to get away with scamming people. According to the FBI, cryptocurrency investment scams accounted for more than $2 billion in losses in the United States in 2022. Cryptocurrencies can also be used for money laundering because most decentralized exchanges aren't required to have robust know-your-customer systems in place.
All DeFi applications are a subset of fintech. Most fintech applications rely on a centralized approach and have management teams that decide how the company is run. Decentralized finance applications don't require intermediaries and are occasionally run as decentralized autonomous organizations (DAOs), meaning they aren't managed by a centralized team.
Fintech applications generally operate within the traditional finance system, interacting with banks and using fiat currency. They are also subject to financial regulations, such as anti-money laundering and data compliance regulations. In contrast, decentralized finance applications use blockchain technology, cryptocurrencies, and smart contracts to negate the need for centralized intermediaries or banks.
DeFi applications aren't regulated as heavily as traditional fintech applications, although many government agencies are working toward DeFi regulation. For example, the Securities Exchange Commission has been looking into cryptocurrencies and other DeFi products in recent years to determine whether certain exchanges have offered unregistered securities. Similarly, the Financial Crimes Enforcement Network (FinCEN) has expressed interest in requiring know-your-customer processes for any money services business that uses digital currencies.
As new technologies emerge, such as virtual reality and artificial intelligence, we'll likely see new applications for fintech and DeFi products. Some fintech companies, such as Robinhood and Cash App, have expressed interest in cryptocurrency and other DeFi products. Over the years, more fintech companies are likely to embrace the DeFi revolution.
Distributed ledger technology and smart contracts could provide excellent cost savings for fintech companies by automating many aspects of their businesses, including reconciliation. Still, fintech companies require a network with low fees and high throughput. Otherwise, they may inadvertently slow their applications down, leading to customer attrition.
Hedera is one of the best-suited for fintech applications. Hedera is capable of processing 10,000 transactions per second. Comparatively, the Ethereum network processes roughly 12 per second, while Bitcoin processes around 3 per second. Hedera is also one of the only carbon-negative DLTs, meaning fintech companies need not worry about the PR implications of worsening their carbon footprint. Hedera is committed to fueling the fintech industry and provided grants to over 20 fintech companies in 2022.