TradFi (Traditional Finance) Explained

TradFi is a new term referring to the old and established legacy financial system composed of central and commercial banks and investment firms.

Unlike the decentralized world ushered with cryptocurrencies, TradFi relies on centralized intermediaries to manage transactions, risk and to provide legal oversight.

Traditional finance is still the primary force behind global wealth, moving over $100 trillion annually through its established network of highly regulated entities.

How TradFi Works

The entire TradFi mechanism operates on a model of centralized trust, which runs in complete opposite of the mantra of the code of law in the crypto world.

TradFi instead relies on human intermediaries that facilitate every transaction you make, so when you make a deposit or buy a stock, you are trusting a custodian like a bank or brokerage to hold your money for you.

These institutions are responsible for handling the clearing process across the global economy, ensuring that you as a buyer have the cash for purchasing a stock, for example, as well as that a seller actually owns the stock you want to buy.

The entire traditional finance system is anchored by central banks like the Federal Reserve, which manage the supply of fiat currency and set the interest rates that determine the costs of borrowing money.

Benefits of TradFi

This well-oiled and established global system still has a number of advantages over the rising decentralized financial systems.

For starters, TradFi offers a much higher level of consumer protection in case of fraud or personal mistakes in financial transfers, due to the fact that you can, for example, simply walk into a bank and use the help of the legal framework to get your money back. 

Traditional institutions are also backed by government insurance like the FDIC, so even if a regulated broker or a bank goes bankrupt, you still have a safety net to be sure that even hundreds of thousands of dollars will be reimbursed to you, which is something that simply does not exist in the decentralized finance market.

TradFi also offers an unmatched level of institutional liquidity, and these institutions are still the only choice for large-scale operations and loans needed by corporations and multi-billion dollar projects.

This is not only a stable system that survived all the bubbles, wars and economic depressions over centuries, but also represents the vast majority of all real-world assets, so whichever major life purchase you want to make, it will be priced and taxed through it.

Disadvantages of TradFi

Despite its safety, TradFi is notoriously slow and expensive. You can still expect international transfers to take a few business days to settle, while the blockchain does this in a matter of minutes.

The other big disadvantage comes from the fact we mentioned before, as every intermediary like a payment processor, clearinghouse or a bank will take a small cut of your money to process the transaction.

Another potentially big issue that affects millions of people are exclusionary barriers, as this system has strict requirements in terms of credit scoring, high minimum balance requirements and accredited investor rules that can not only lock people out of the system, but also create a wealth gap that’s been clearly proven to be expanding more and more over the years.

Lastly, even this massive system is not immune to collapse or failure, which can be catastrophic and lead to the access to your capital being frozen.

Final Words

All in all, TradFi is still the main juggernaut of the financial world, offering a level of security that cannot be matched, while also constantly evolving to maintain its position and improve on the sore points through even increasing digital integrations that make moving money faster and cheaper with each day.