Blockchain and DeFi primer

A blockchain is a distributed ledger, a database that is simultaneously maintained by many participants rather than a single central authority. Entries (transactions) are grouped into blocks, cryptographically linked together in a chain, and validated by network consensus. The result is a tamper-resistant record that no single party can alter without the agreement of the network.

Blockchain's key innovation is enabling trust without a trusted intermediary: two parties can transact directly, with the network verifying the transaction, rather than relying on a bank, clearinghouse, or government registry as a trusted third party. In financial applications, this can speed up settlement, reduce costs, and enable new forms of asset ownership.

Decentralised Finance (DeFi) extends this by building financial services, lending, borrowing, trading, asset management, entirely on smart contracts on a blockchain, without banks or brokers. While DeFi is still largely unregulated and carries significant risks, understanding its mechanics is increasingly relevant for financial professionals.

Core concepts:

Distributed ledger: Database maintained by nodes across a network. Changes require consensus. No single point of control or failure.

Consensus mechanisms:

• Proof of Work (PoW): Nodes compete to solve computational puzzles (Bitcoin). Energy-intensive.
• Proof of Stake (PoS): Nodes "stake" cryptocurrency as collateral; selected to validate based on stake size (Ethereum post-Merge). Energy-efficient.

Smart contracts: Self-executing code on a blockchain, automatically enforce the terms of an agreement when pre-defined conditions are met. No intermediary needed.

Tokens:

• Cryptocurrency: Native currency of a blockchain (BTC, ETH). Speculative asset in most regulatory frameworks.
• Utility token: Access rights within a platform
• Security token: Represents ownership in a real-world asset, regulated as securities in most jurisdictions
• Stablecoin: Price pegged to fiat (USDT, USDC) or algorithmically stabilised

DeFi protocols:

• DEX (Decentralised Exchange): Trade tokens peer-to-peer via smart contracts (Uniswap, Curve)
• Lending/Borrowing: Deposit collateral, borrow against it (Aave, Compound). Over-collateralised.
• Yield Farming / Liquidity Mining: Provide liquidity to protocols for token rewards

India's Digital Rupee (CBDC): RBI launched e₹ (digital rupee) pilots in 2022–23. A CBDC is a digital form of sovereign currency, not a cryptocurrency. Issued by the central bank; full faith and credit of the sovereign.