In recent months, a lot of people made loads of money through margin and futures trading in cryptocurrencies. They got used to winning so much that their risk appetite increased exponentially and they became careless. I know some retail traders from Nigeria who were collecting profits of up to $70000 dollars per trade and they would risk it all again the next day. The crypto market became a very profitable gambling house and risk management became a thing of the past. I remember reading an X post that said:

“Stop losses are for cowards bro! Real men go full margin at x100”

Now, all it took was a social media post from Donald Trump and the whole world came crashing down in a matter of minutes. Trading accounts ceased to exist and wallets started looking like they were newly created. It was the biggest liquidation event in the crypto world and the complacent were punished. Lessons were learnt at the costs of billions of dollars. 

But, what did this teach us about the perceived decentralisation of cryptocurrencies? Would this have happened if the money was in a high yield savings account in a bank somewhere? Well, provided that the bank is reliable, not one that can convert your USD to a useless currency without warning! This is what I am trying to decipher today and if by any means my article offends you, I am not sorry, after all views differ and I agree to differ with your views.

The world of finance at crossroads

As of today, the world stands at financial crossroads. For a very long time finance was controlled only by traditional financial banks and governments. They used to control how all the money flows, how transactions are processed and how financial services are delivered. Even today, they still have a lot of this control but it has been eroded to a greater extent by the use of cryptocurrencies.

In recent years, a new contender has emerged to the throne of controlling world financial systems and its decentralised finance (DeFi). DeFi is powered by blockchain technology and it has revolutionised the way anyone can manage money. With DeFI we no longer need a lot of unnecessary middlemen to receive, borrow or lend money. Control of transactions, storage and flow of money has been more or less in the hands of the end user.

this means that centralized institutions are losing some of their control over the flow of money. But also, DeFi has been unable to completely wrestle control of financial systems from centralised institutions. So, it leaves us to ponder, who will win the future of finance, decentralised or centralised financial systems? Or the two will find ways to coexist like two sides of the same coin.

Understanding the key players in the financial world

Centralised Finance

Centralised finance refers to the traditional institutions like banks, insurance companies and stock exchanges. These are entities which act as your trusted intermediaries, overseeing and regulating transactions. This is crucial because it ensures that there is security, compliance and stability of all transactions. It also means that transactions can at least be traced to the owner of an account if there is need. Most of the time the centralised financial systems have strong KYC requirements and if you default on loans or payment it's easier to trace you.

The central banks of governments and regions also wield significant influence in how centralised finance works. They manage monetary policies and currency systems. Since, centralised systems have long standing infrastructure adoption is wider, there is regulatory oversight and consumer protection. So, yes, on paper centralised finance is not bad at all!

Decentralised Finance

Decentralised finance on the other hand is a financial system built on blockchain technology. Some DeFI platforms are built on blockchain platforms such as SUI, Etherium, Ton and Arbitrum. DeFI does not use middlemen but rather it uses smart contracts. Smart contracts being self executing codes can help in facilitating all financial services without any middlemen. In other words, in DeFI you can lend, borrow, trade and earn interest without anyone asking you to come to the bank to see the manager or sign a large pile of papers.

The beauty of DeFi is that it does not matter if you are in a mountain or forest area detached from civilization, as long as you have a smartphone and internet, you can participate. And DeFI is borderless, operates 24/7 and has no weekends. It is also very resistant to some forms of censorship.

Strengths and limitations of centralised finance versus DeFi

Centralised financial control

Strengths

• There is security and trust because authorities and intermediaries follow strict rules and regulations.
• Intermediaries usually have resources to protect your assets through security and insurance. The FDIC in the U.S for example insures bank deposits up to $250000.
•  Centralised systems ensure that there is stability and authorities can intervene during crises to stabilise markets.
•  Global economies run on this centralised system and it also still runs most financial components of everyday life as it is widely adopted.

Weaknesses

•  Centralised finance lacks transparency. Most of the time we don’t even know where a decision was made or by who. In addition restrictions like financial sanctions can affect the general public while they have no idea why.
• There is limited access in centralised finance. In some countries you have to travel hundreds of kilometers to see a bank. If a small amount is sent to you in such a case you can just ignore it because it might not even cover transport fare.
•  You have to work within specified periods of time. Most banks only work from 9 am to 3 pm on business days and to 2pm on Fridays. Even if it's urgent and you got the message late on Friday you have to wait 2 days.
• Because everything is regulated by central banks, any innovation has to go through several layers of scrutiny and approval, only then can it be used. So, new financial products take years to  be approved.

DeFi

Strengths

• DeFi is financially inclusive as anyone with a smartphone can access the protocols. People with no traditional bank access can access it easily and even people with very small amounts can access with very low minimum amounts.
• Even if you are unemployed you can still access DeFi which may differ from some banks which require proof of employment.
• DeFi is built on blockchain technologies so transactions are publicly recorded and can be audited.
• Since there is no bureaucracy, there is rapid innovation and development of new financial tools to challenge existing models.

Weaknesses

• High security risk remains a pain in DeFi. Smart contract bugs and hacks have led to serious financial losses. According to Chainanalysis, the losses were over $1 billion by 2022. And if you sign the wrong contract your wallet can be drained.
• There is also a lot of regulatory uncertainty in DeFi. Because there is no clear regulation, risks of exploitation, misuse and fraud are very high.
• While centralised finance can scale up and down according to demand, DeFi still has a long way to go. This is because current blockchain networks face serious challenges of transaction speeds and costs.

Views of experts who may also be biased!

One of the biggest financial institutions in the world, the IMF warns that while DeFi offers exciting opportunities for inclusion and innovation, it remains fragile and unregulated. This was from the IMF report of 2023. Well, I would expect such a stance from the IMF. They belong to the centralised financial system and I bet they can feel their control slipping away on a daily basis. While their concerns are valid, some of the best things in DeFi are there because of this lack of regulation. And they will disappear as soon as this regulation is introduced. This would make DeFi less attractive. However, the IMF also understands the need for cautious integration with existing centralised financial systems which may not be a bad thing.

Other groups like the Bank of International Settlements, view a full decentralised financial system as unlikely in the short term. However, they believe that hybrid systems may be of use in the near future as they will join the safety of the centralized systems with the convenience of DeFi.

While other institutions are still in the we don’t want DeFi era, others like JPMorgan Chase are investing heavily in blockchain technologies. Many companies in the centralized finance space are actively researching ways of integrating DeFI elements in traditional banking systems. This means that the future of the world's financial systems might not be fully centralised or decentralised but something that involves both.

My views on the future of finance

I do not think that there will be a time where we will be totally dependent on DeFi in the near future. Not, until the rest of the world catches up and closes the technological gap that exists between 1st and 3rd world countries. This will also only occur when the issues with scalability of blockchain networks have been eliminated completely. Just imagine this, if a network cannot handle 2 million transactions what happens when there are 20 billion transactions at the same time period? Yes, a disaster happens in terms of delays and high transaction fees. This would make the whole concept of DeFi useless.

However, with many central banks coming on board we may see a hybrid version of financial systems which will have both centralisation and decentralisation.

Some groups who dare to dream have been talking about the possibility of a regulated form of DeFi. Regulated DeFi protocols comply with KYC rules and anti money laundering regulations. This addresses some of the biggest challenges in DeFi while maintaining innovation and user control. I have seen the DeFi App, an app that restricts people from my jurisdiction due to economic sanctions compliance.

Central bank digital currencies are issued and controlled by central banks. An example is that of the recently launched digital yuan which is in pilot use. These digital currencies combine digital convenience, trust and regulatory oversight.

So, while complete decentralisation of the world’s financial systems is a fools’ dream in the near future, hybrid systems may work much better than each stand alone system.

Conclusion and final thoughts

With current technology there is no way we can do away with centralised financial systems because they bring stability, security and trust. We need centralised financial systems for large scale economic activities to function properly. However, centralised systems are slow and exclusive and this makes DeFI attractive. Decentralised finance on the other hand brings innovation, inclusivity and transparency but it is also high risk in terms of security. 

So, if you ask me the winner of the future of finance, I would tell you that it's not DeFI and it's not centralized finance. In the near future, hybrid systems will win. Systems that will combine the best of both decentralised and centralised financial systems. A hybrid financial ecosystem will harness the innovation of decentralisation without sacrificing stability and protections that come with a centralised system. 

And when the systems evolve, the real winners will not be systems of finance, real winners will be us the users. We will gain greater access, control and choice over how we want our money to move.