“Decentralization” is the core concept of DeFi. While more complex than Satoshi’s original vision, the guiding goal of today’s DeFi developers is the same as the one behind his original Bitcoin white paper.
Traditional financial institutions are centralized, in that all customers must transact via a bank or exchange, which will validate and facilitate those transactions and act as a custodian for assets. In a decentralized network, transactions are person-to-person (P2P), and assets are held in fragmented form across multiple computers or nodes rented out by private individuals.
The absence of an intermediary means: 1) lower cost 2) faster speeds. The system is also more reliable as it (in theory) eliminates the potential for human error, and less biased in that services are open to all.
The rise of the dApps
Smart contracts developed for the blockchain that facilitate specific processes are known as decentralized apps (dApps). DeFi dApps map on to the core functions of a bank: Payments, Saving, Borrowing, and Trading.
Escrow is an example of a traditional banking function that can be easily replicated and enhanced as a dApp in the DeFi universe.
When submitting advance payment for a service, the traditional approach requires a third party (such as eBay) to hold on to the funds and decide when to release them. This requires bureaucracy and cost, and also opens the door to human error. eBay also has the power to refuse transactions and block users from the platform.
In a ‘trustless’ escrow scenario, the transaction is intermediated entirely by a smart contract, which releases the funds if and only if the agreed conditions are met.