The rise of decentralised finance over the past decade has changed the way people perceive money and financial systems.
What was once a system constrained by geographical borders and institution-caused delays has now transformed into a global network where value can move instantly across the globe.
While this shift of value is a refreshing new jump in innovation and convenience, its advancement doesn’t mean the obsolescence of traditional banking rails.
In reality, both these new DeFi protocols and established banking rails coexist and support each other to improve the financial processes for real-world transactions and business operations.
If you’re curious to learn more about this intersection, then read on. This article will delve into this hybrid model and how it’s currently shaping both the present and future world of global finance.
Let’s dive right into this topic.
Explaining Banking Rails
It’s essential to familiarise yourself with the concept of banking rails before exploring the intersection between them and DeFi protocols in greater detail.
Banking rails essentially refer to the financial infrastructure that enables money to move between institutions and their clients. Think of it like the underlying network that facilitates the transfer of payments.
Some examples of banking rails include everyday credit card transactions, bank transfers, and international remittances. Money moves through these banking rails—and if they don’t operate as intended, this could halt the smooth transfer of money across local and global communities.
That being said, while banking rails are reliable and deeply embedded in the global financial system, they are not without limitations. Transactions pass through multiple intermediaries and operate within fixed hours. They’re also subject to higher fees and potential settlement delays, particularly for transactions beyond local borders.
With these concerns being a fundamental drawback of traditional banking rails, alternative financial systems like DeFi protocols such as Uniswap emerged and offered solutions to these longstanding issues.
What are Defi Protocols, Exactly?
DeFi protocols, short for decentralised finance protocols, are financial systems that run on a peer-to-peer technology called the blockchain.
A blockchain is a digital ledger that records transactions across multiple computer nodes rather than storing data in a single central location. This distributed structure ensures that all records are transparent, verifiable, and extremely difficult to alter, helping build trust without relying on a central authority.
Built on top of this technology, DeFi protocols automate financial activities without relying on traditional intermediaries. Transactions of all kinds—including borrowing, trading, and lending activities, are independently run and executed between users.
The system operates with the help of smart contracts, or self-executing programs built with predefined rules. If the right conditions are met, actions such as the transfer of funds or payment of interest are carried out without further intervention.
For instance, a user can lend their digital assets through blockchain systems and earn interest via smart contracts. No bank or intermediary is involved, meaning the asset can be transferred and the request can be approved with ease.
Where DeFi Protocols and Traditional Banking Rails Intersect
Now that you’re familiar with these two concepts, the question then becomes, how do these two concepts intersect?
While DeFi paves the way for decentralised, on-chain financial activity to take place, most real-world business expenses still operate through Web2 infrastructure, so to speak.
Web3 companies may generate revenue or manage their equipment through DeFi protocols, but they still need traditional banking rails to perform a slew of company activities.
Activities like paying employee wages, settling supplier invoices, managing taxes, and handling everyday operational costs are fundamental for businesses to operate—and these are covered by Web2 infrastructure.
In fact, some features can only be executed by the Web2 infrastructure at this time. Two prime examples of this are managing multi-currency accounts and paying bills, which can be made easier with software tools like OFX.
Defi protocols introduce a new wave of innovation to traditional banking features. They introduce speed to typical operations, cutting down transfer times from days to seconds. They also help automate and verify transactions through a paper trail.
Risks of Bridging DeFi and Banking
While the convergence of DeFi protocols and traditional banking rails has its benefits, it also comes with a new set of challenges that must be managed. Below are three of the most notable ones to consider.
Regulatory Uncertainty
DeFi operates in a space that’s still inherently new and emerging. Governments across the world regulate cryptocurrency differently from one another. Some embrace it and allow citizens to use it liberally, while others impose some restrictions and harsh penalties if caught using these tokens.
Given the varying freedom that the global populace has with DeFi across jurisdictions, this can complicate compliance for businesses operating internationally or individual users looking to incorporate Web3 solutions in a restricted environment. In essence, interested entities must navigate differing legal requirements, which can add operational strain.
Security Vulnerabilities
While blockchain networks are independent and tamper-resistant from any third party, this puts more pressure on the user and businesses to ensure that their digital assets are secured.
Private keys and wallets, like Ledger, must be properly managed, as there is often no central authority to reverse transactions or recover lost funds. The risk is compounded for users new to the scene who may not be familiar with common scams and fraud attempts.
Operational and Integration Complexity
Another potential challenge in managing both DeFi platforms and traditional banking tools is the operational complexity in harnessing the potential of both systems at once. Users and operators will need to have a clear oversight of the system to ensure that they’re properly integrated and beneficial in their intended purpose. That said, once you have specialised knowledge of banking and DeFi networks, then you can make the most of these two systems and manage your finances better with few downsides.
We hope that this article has given you clearer insights into the connection between traditional banking systems and decentralised finance.
