DeFi – Decentralised Finance: what it is and how it works

The world of fintech is becoming increasingly rich in acronyms, often referring to the English language, but DeFi is one of the acronyms that should be remembered in the coming years because it is giving shape to a new way of conceiving the mechanisms that have always guided the world of finance. Behind Decentralised Finance (hence DeFi) lies an innovative way of thinking that does not accept monopolies rather is based on openness, free competition and collaboration.

DeFi: what is it?

When we talk about decentralised finance, we refer to the organisation of services that are reminiscent of banking services but embedded in infrastructures that do not have any kind of hierarchy. This could be the blockchain, distinguished by this characteristic as well as others, the important thing being they are less centralised than the banking system.

From this distinctive characteristic derives the possibility of executing transactions without any external intervention, through automatisms such as those defined by smart contracts.

Today, DeFi can also be understood as a real movement closely linked to the world of cryptocurrencies, born with the aim of bypassing the traditional scheme in which banks are in contro, l in order to offer classic banking services without any intermediation.

DeFi: applications

Although it is a rather new sector, we hear a lot about it because it has been one of the most buzzed about sectors in recent months. On the one hand, because it is releasing various services able to meet the current needs of the end customer in a high-performance manner, and on the other hand, because it greatly facilitates the integration of different projects and gives rise to new ones.

Investors, too, have realised the concrete opportunities of DeFi and can rely on one of the already numerous applications available today. Decentralised finance enables the exchange of digitised assets and tokens as well as facilitating loans with automatic execution. Common to the different DeFi-based projects we can encounter there is always the intention to replicate services provided by banks, exchanges and stock exchanges in a new way without intermediaries through the use of blockchain and smart contracts.

DeFi: how it works

Once we understand what makes DeFi innovative and different from previous models of finance, namely the absence of central structures that act as the core of the mechanisms on which the services are based, we are already well on our way to better understand the possible declinations and use cases.

This type of model is based on the use of the blockchain and on tools such as those applied by Bitcoin or more functional cryptocurrencies such as Ethereum. The functioning of DeFi is based on a few simple concepts that are worth exploring one by one:

Payments. This means an exchange of values are not based on the old cryptocurrencies, tokens, but offer something better because they allow integration with other blockchains that can offer services related to those of payments. This connection can be made directly or via an additional blockchain.

Contracts. Smart contracts are at the heart of DeFi and are based on algorithms executed whenever precise pre-defined conditions occur. Although smart contracts have existed for a long time, they have  only begun to be used casually in the last two to three years, including for the creation of decentralised exchanges, which are faster, cheaper and more secure.

Data for contracts. Data cannot but be a key player in this new area also  called DeFi, and is in conjunction with the use of smart contracts. These innovative contracts, for example, can be executed automatically when data arrives from outside the blockchain world. Some of DeFi’s projects revolve around data and provide other blockchains or projects with it so it can be used in dApps or contracts.

Loans and remunerated deposits. We come to one of the simplest, most concrete and popular examples of services offered by DeFi which are those that related to loans to be obtained. There are systems that allow borrowing new generation cryptocurrencies and stable coins, which are still based on the value of a classic currency. These types of decentralised finance projects are considered interesting and convenient because they are a solution to the lack of liquidity that companies may experience, allowing them to have funds for their projects on the one hand and on the other to be remunerated for having deposited resources.

Blockchain. The centrality of the blockchain in this new sector, or of any mechanism resembling, is undoubted, because decentralisation depends on it. The blockchain and algorithms on which it is based are what allow for secure exchanges without the involvement of institutions, but this is not the only value of the blockchain in this new context. It is also very important because it allows the traceability of different transactions and guarantees a certain level of transparency. Horizontality, however, it is not guaranteed because there are also systems implemented using supernodes that play a predominant role, but this does not make DeFi any less decentralised.