Decentralized finance versus traditional finance and the reasons for its rise

In recent years, decentralized finance (DeFi), as an emerging financial ecosystem, has gradually attracted widespread attention and discussion. Compared with the traditional financial system, DeFi has not only challenged the basic principles and operation mode of traditional finance, but also triggered a wave of financial innovation worldwide. The purpose of this paper is to make a systematic comparison between decentralized finance and traditional finance, and to explore the similarities and differences between the two in terms of structure, function and risk management. At the same time, we will also analyze the reasons for the rise of decentralized finance, including technological advances, changes in user demand and the development of the regulatory environment, with a view to providing readers with a comprehensive perspective and understanding of the deep-seated logic behind this phenomenon.

Basic Definition and Functional Comparison of Decentralized and Traditional Finance

Decentralized Finance (DeFi) is a financial ecosystem based on blockchain technology that aims to enable intermediary-free financial services through smart contracts. Compared with traditional finance, decentralized finance has the following characteristics:

• high degree of transparency

  : All transaction records are publicly available on the blockchain, enhancing trust.

• without borders (used for organizations such as Médecins sans Frontières)

  : Anyone with an Internet connection can participate without a bank account or identification.

• ability make one's own decisions

  : Users control their own assets without having to rely on intermediaries.

In contrast, traditional finance relies on centralized institutions such as banks and finance companies to provide credit, savings, insurance and other services. Their main functions include:

• risk management

  : Help users manage financial risk through insurance and investment products.

• financial liquidity

  : Provide users with liquidity options such as savings and loans.

• credit rating

  : The decision to grant credit is made by evaluating the borrower's data.

In the functional comparison between the two, it can be seen that decentralized finance greatly reduces barriers to entry and makes financial services accessible to more people, while traditional finance performs more maturely in terms of auditability and credit assessment. This difference reflects the different pursuits of different financial models in terms of anonymity, transaction efficiency, and user experience.

Analysis of the reasons for the rise of decentralized finance and the technological background

The rise of decentralized finance (DeFi) stems from a response to the multiple challenges and limitations of the traditional financial system. Traditional finance is centralized in many ways, leading to uneven distribution of resources, lack of transparency, and invasion of user privacy. As a result, decentralized finance has emerged, looking to leverage the benefits of blockchain technology to create an open, transparent and trustless financial ecosystem. Its rise is mainly due to the following reasons:

• Technological advances:

  The maturity of blockchain technology provides secure data storage and transaction verification mechanisms for decentralized finance.

• User Requirements:

  The importance users place on financial autonomy and privacy is driving the widespread adoption of decentralized finance.

• Infrastructure innovation:

  The emergence of smart contracts and decentralized applications allows developers to quickly build rich financial products.

From a technical background, most decentralized financial protocols are built on top of blockchain platforms such as Ether, which support the deployment and execution of smart contracts. Smart contracts automate transactions and reduce reliance on intermediaries, while improving the security and efficiency of transactions. For example, decentralized exchanges (DEX) allow users to exchange assets directly without relying on traditional exchanges. Some of the key technical features are summarized below:

Impact and Challenges of Decentralized Finance on the Traditional Financial System?

In today's rapidly evolving financial markets, the rise of digital currencies has sparked widespread interest in the traditional monetary system. In particular, the launch of the Central Bank Digital Currency (CBDC) has brought a new perspective to revisit the traditional monetary system.The CBDC is designed not only to improve the efficiency of payments, but also to maintain the effectiveness of monetary policy in the digital economy. As the economic environment changes, the CBDC is able to respond more flexibly to financial crises and participate in global capital flows to ensure national financial security. This change could fundamentally affect the issuance mechanism of traditional currencies, their circulation patterns and the basis of trust behind them.

In summary, the characteristics of the digital currency of the Central Bank in comparison with the traditional monetary system can be analyzed in a number of ways. The main points are as follows:

• Security:

  CBDCs typically use advanced encryption to provide higher security.

• Transparency:

  Based on the technical characteristics of the blockchain, it makes the transaction process traceable and improves transparency.

• Efficiency:

  CBDC provides instant settlement and reduces transaction costs.

• Programmability:

  CBDC is able to implement smart contracts that automatically enforce the terms of the contract.

When comparing their origins, while traditional currencies were primarily driven by their development based on physical assets or state credit, CBDC is more closely linked to technological advances. This has not only helped to solidify users' trust in the digital economy, but also provided new solutions for avoiding future economic risks. All in all, the introduction of CBDC marks a major change in the field of currency, the impact of which will profoundly alter the structure and mode of operation of the future financial system.

Future Development Trends and Recommendations for Investors

As Decentralized Finance (DeFi) grows rapidly around the world, the market is showing great interest in its future prospects.The rise of DeFi is not only due to technological advances, but also reflects the recognition and pursuit of transparency and efficiency in the traditional financial system. Forecasts suggest that DeFi is likely to continue to drive innovation in financial services and enhance user experience in the coming years. Against this backdrop, there are several trends that investors can look out for:

• Technology maturity:

  With the continuous development of blockchain technology and smart contracts, the reliability and security of decentralized financial applications will be greatly improved.

• Compliance Reform:

  Regulators in various countries are gradually developing regulations to ensure the legitimacy of decentralized financial activities, which will facilitate the participation of more institutional investors.

• Cross-chain interoperability:

  Interoperability between different blockchains will further erode the limitations of a single platform and provide users with more flexible financial tools.

For investors, the decision to enter the decentralized finance market should be based on a deep understanding of industry dynamics. First, investors need to assess the actual application scenarios of the projects and their technological background to determine their future growth potential. Secondly, it is advisable to focus on the governance structure and community involvement of decentralized finance protocols, which can reveal the long-term sustainability of the project. It is also essential to establish a risk management strategy that takes into account the impact that market volatility may have on investment returns. To help investors better understand the current market situation, the following concise risk-return comparison can be consulted:

Concluding Remarks

In this paper, we explore the comparison between decentralized finance (DeFi) and traditional finance, analyzing the differences between the two in terms of structure, mode of operation, transparency, and risk management. At the same time, we explore the reasons for the rise of decentralized finance, including factors such as technological advances, changes in user needs, and challenges to the traditional financial system. Against the backdrop of the rapid development of fintech, decentralized finance has shown great potential, attracting more and more investors and users. However, while DeFi offers greater flexibility and innovation, it also comes with corresponding risks and uncertainties. In the future, we need to study the interplay between these two financial systems and their impact on the global financial market in greater depth in order to better understand the long-term implications of this emerging phenomenon.