Introduction

The earliest form of trade was peer-to-peer, also known as the barter system. Barter was considered inefficient because supply and demand could never be exactly matched between peers. To overcome this matching problem, money was introduced as a medium of exchange. Early issuance and circulation of currency were not centralised. Eventually, as time progressed, the currency had tangible value and the issuance of currency was institutionalised and controlled by central banks. Even though the form of money has changed over time, the basic infrastructure of financial institutions has not changed.

However, the stage is now set for a historic disruption of our current financial infrastructure. Decentralised Finance or DeFi uses cryptocurrency and blockchain technology to manage financial transactions. It aims to make finance easily accessible to all by replacing legacy, centralised institutions with peer-to-peer relationships that can provide a full spectrum of financial services, from everyday banking to loans and mortgages, to complex contractual relationships to trading in assets.

Considering its cost-effectiveness in providing financial services to customers, it is expected that DeFi will replace the majority of centralised financial infrastructure in the future. DeFi offers considerable potential for solving the key problems associated with centralised finance, like, centralised control, limited access, inefficiency, lack of interoperability, etc. The rapidly growing landscape of DeFi applications presents a plethora of future opportunities which can benefit from the network effects of combining and recombining DeFi products and capture the lion’s share of the financial ecosystem.

What is DeFi?

DeFi typically refers to the decentralised applications providing financial services on a blockchain network. DeFi is based on a peer-to-peer philosophy that typically operates without centralised intermediaries or institutions and uses open-source protocols that allow services to be programmatically combined in flexible ways. DeFi tends to make finance easily accessible to all and seeks to replace the traditional centralised institutions such as banks, financial institutions and NBFCs (Non-Banking Financial Companies). It relies on the self-executing ‘smart contracts’ on the blockchain network with zero human intervention, thereby reducing the chances of errors and increasing efficiency. Some of the key features of DeFi that attract a wide range of consumers are:

• It eliminates the fees that banks and other financial institutions charge for providing financial services.
• The consumer holds the money in a secure digital wallet instead of keeping it in a bank.
• The components of DeFi are stablecoins (a type of cryptocurrency backed by an entity or pegged to a currency like dollar), software, and hardware that enables the development of applications.
• Anyone with an internet connection can use it without needing the approval of any central authority and funds can be transferred almost instantly.

How does DeFi differ from CeFi?