TradFi and DeFi Are Two Sides of the Same Coin

Written by Dr. Chan Ahn, the Founder and CEO of Tessera

The world of TradFi is often associated with compliance and gatekeeping, whereas DeFi emphasizes permissionless composability and open access. But TradFi and DeFi are not incompatible. On the contrary, TradFi’s core legal primitives function more efficiently on-chain.

For instance, TradFi’s debt and structured credit are highly DeFi-compatible due to their distribution of economic exposure. After all, TradFi’s logic has better execution environments on-chain with instantaneous settlements, composable positions, and global access.

Ultimately, finance is not about creating binaries between TradFi and DeFi for an endless tug-of-war. Instead, it’s about recognizing how each of them solves problems to expand accessibility for all.

TradFi and DeFi Are Overlapping

Loan syndication in TradFi mitigates risk by distributing it across multiple lenders. Consequently, participants absorb the economic exposure without the origination work of identifying financing requirements and loan structures.

DeFi lending protocols work very similarly because their economic logic is identical to TradFi. Lenders provide crypto assets to a DeFi protocol’s liquidity pool in exchange for yield, with eventual repayment of principal.

An automated on-chain loan structure is highly composable because it can be tokenized, exchanged, used as collateral, and deployed into yield strategies without the constraints of securities classification.

However, tokenized equities, which often represent securities, can’t function like on-chain loans. Most web3 protocols directly tokenizing private equity make the mistake of classifying them as securities. Securities can never provide liquidity to a DEX pool or be used in lending protocols. Loans can, because their onchain structure is different.

So, it’s necessary to design tokenized equity in an on-chain loan-like structure by adopting the best practices from TradFi and DeFi to maximize efficiency and accessibility.

TradFi’s gatekeeping is perhaps best demonstrated in private market opportunities. Most of these investing options are reserved exclusively for HNIs and institutions with billion-dollar funding capacity, along with high minimum investment thresholds and long vesting schedules. The settlement infrastructure is also very slow, with transfers taking weeks due to paper documentation and manual settlements.

Consequently, private equity, one of the best-performing asset classes historically, remains inaccessible to retail investors. In effect, only accredited investors and VC funds are the sole beneficiaries, profiting from early investments into companies with revolutionary technologies and massive growth potential. To put things in perspective, an estimated $7 trillion remains locked out of reach, preventing participation from the wider market.

Bringing the Best of TradFi and DeFi Together

To retain the upsides of TradFi’s private market opportunities while making them compatible with DeFi, asset exposure must be rethought. Innovative tokenization solves the problem with stablecoin-led instant payments, blockchain-powered token transfers, and transparent on-chain verification.

Lenders can provide stablecoins and receive tokens that represent loan participation rights – their proportional share of exposure to the underlying private company’s performance. The best tokenized private equity protocols won’t gatekeep participation by eliminating minimum investment requirements and long lockup periods.

The tokens can be traded and transferred on DeFi protocols instead of sitting idle. Instead of complex settlement procedures and KYC checks, holding and sending tokens becomes seamless, facilitating seamless DeFi composability.

With users’ private asset exposure held in separate, legally coherent portfolios, round-the-clock trading enables live price discovery rather than waiting for quarterly reports, thereby boosting liquidity. Protocols can also create equitable opportunities for participation by enabling users to deposit funds during pre-defined auction windows and by transparently handling allocations.

Eventually, when private companies go public through IPOs, acquisitions, or secondary sales, retail investors can participate in the liquidity event. It’ll help investors to liquidate their underlying exposure to the companies and claim their share of the loan amount in stablecoins.

Simultaneously, if protocol tokens remain liquid, users can easily transfer them, trade on DEXs, provide liquidity in exchange for fees, and leverage them in lending-borrowing protocols. In other words, the protocol tokens representing private-company exposure will be fully DeFi-compatible, thereby maximizing their capital efficiency.

Private market opportunities can thus have abundant liquidity and be accessible to all by deploying advanced tokenization models. They help to transform capital markets, reshaping how profitable private companies are funded and how investors profit from them.

It is possible to adhere to TradFi’s legal and compliance standards while modernizing distribution, asset exposure, and settlement mechanisms. By aligning TradFi with DeFi’s standards, the participation base widens and ownership profiles change as distribution is reframed.

Equity can’t be forced into a permissionless world of DeFi. Decentralized loan structures show how TradFi and DeFi can come together to share the best of both worlds. At the end of the day, it’s about modernizing financial infrastructure by bringing Wall Street’s primitives on-chain to facilitate global access and inclusivity.

Disclaimer: High risk. Not financial advice. See terms.