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DeFi: The Future of Finance?

Defining DeFi

DeFi takes a multitude of forms, and currently defies strict definition (although we expect authorities to seek to do so over the coming months and years). However, at a very high level, DeFi involves the use of smart contracts, digital assets, protocols and algorithms to mimic different types of financial transactions, without relying on a trusted intermediary.

Broadly speaking, the term ‘DeFi’ refers to financial services provided in accordance with the following characteristics:

DeFi products and services take the form of software and protocols, which sit on top of the decentralised foundations of blockchain technology and rely heavily on the implementation of blockchain-based smart contracts and algorithms.

DeFi technology provides users of cryptoassets and tokenised assets with new ways to create, manage and transact in those assets (as well as traditional securities). Once instructed, or once specified conditions are met, DeFi protocols can automatically prompt settlement according to the usual processes for the specific asset (eg over the Ethereum blockchain for Ethereum-based assets and tokens). 

Crucially, DeFi services don’t require any third-party intermediary to take custody or control of user assets or funds, as all transactions are executed and recorded through smart contracts and algorithms according to the DeFi protocol’s predetermined rules. 

DeFi services are made available to users directly through decentralised web applications (DApps) and crypto-wallets. These DApps and wallets may be created and managed by a single person (whether natural or legal), a community or even a decentralised autonomous organisation (DAO), although these ‘controlling persons’ (for lack of a better term) would typically define the terms of the protocols that apply, rather than defining the terms of any particular transaction using those protocols.

The financial services that may be replicated through DeFi are numerous and growing in line with the increasing sophistication of the technology and protocols that support DeFi. We outline a number of examples on the following pages, but the most popular examples of DeFi protocols replicate exchanges, credit products, derivatives and insurance.