Decentralized Finance Explained: What Works Without Banks and What Does Not

Why decentralized finance matters to owners too

Anyone looking into crypto assets quickly comes across offers with astonishing promises: interest on stablecoins far above savings rates, loans in seconds without a credit check, trading around the clock without an exchange. Behind them is usually a field called decentralized finance, DeFi for short.

This article therefore asks: What actually works in decentralized finance without banks, what does not, and what does that mean for a business that comes into contact with crypto assets? To answer it, we first clarify the terms, then present Schär's layer model as a thinking model, look at what works and where the risks lie, weigh two readings, and finally derive a test for your own business.

What is decentralized finance? The key terms

The basis is smart contracts, small programs stored on a blockchain and executed in parallel by many computers. Schär (2021) emphasizes their core: they run exactly as programmed, and anyone can check the code and the results. They can hold crypto assets themselves and release them according to fixed rules. Most applications run on Ethereum, the largest platform for such programs.

The computer scientist Nick Szabo, who coined the term in the 1990s, described the idea with a vending machine: coin in, drink out, without a seller and without trust in a person. The machine enforces the contract itself. The image goes a long way, and it also shows the limit. A machine cannot check whether the coin is stolen, and if it is built wrongly, nobody gives the money back.

The thinking model: Schär's layer model

Schär (2021) organizes decentralized finance in a model of layers built on top of each other. It helps to ask, for each application, exactly where which risk lies.

The model's strength lies in composability: every layer can access every other, like building blocks that interlock. Schär describes how one can buy a dollar stablecoin on an exchange, lend it at interest on a lending platform, and add the interest-bearing claim to a further pool. Therein also lies the weakness: if one block fails, everything standing on it fails too.

In decentralized finance, trust does not disappear. It only changes place, from the bank to the code, to the data provider, and to those who vote on changes.

What works without banks

Some things decentralized applications genuinely do without a classic intermediary, and reliably so, as long as the code is free of errors.

• Token swaps. Decentralized exchanges swap crypto assets around the clock, without an account at a trading venue. The price results from a formula and the contents of the pool.
• Collateralized loans. Anyone who deposits crypto assets as collateral worth considerably more than the loan can borrow without a credit check. If the value of the collateral falls below a threshold, the program sells it automatically.
• Transparency. All holdings and transactions are publicly visible. Unlike at FTX, where customer funds were moved unnoticed, a protocol allows anyone to check at any time what is in the pools.
• Open access. Anyone with a wallet can take part, without an application and without opening hours.

How differently a central exchange without such visibility can fail is shown by FTX. That transparency has its limits too is shown in the next section.

What does not work without banks, and where the risks lie

The limits are just as clear. They follow from the vending machine: a program knows no persons, no intentions, and no world outside the blockchain.

• Unsecured loans. A working capital loan to a trade business presupposes that someone knows the business and can enforce claims in a default. Without identity and legal recourse, that is not possible. This is why lending protocols demand overcollateralization, and precisely why they hardly help businesses without crypto assets.
• The link to the real world. Whether a container has arrived or a price is correct, the blockchain knows only through data providers. Whoever manipulates them manipulates the protocol.
• Protection against mistakes. A wrong transfer, a bug in the code, or an attack cannot be reversed. There is no deposit protection and usually no contact person.
• Euros for everyday use. For salaries, taxes, and suppliers, a business needs euros in a bank account. The way there leads back through regulated intermediaries.

How large the risk from attacks is can be seen in figures from the analytics firm Chainalysis. In 2022, around 3.8 billion dollars in crypto assets were stolen in hacks, more than ever before. About 82 percent of that, around 3.1 billion dollars, came from DeFi applications, a large part from so-called bridges between different blockchains.

Two readings: open infrastructure or an illusion of decentralization?

Opinions on the value of decentralized finance diverge widely.

Schär (2021) takes a cautiously positive view. Decentralized finance, he writes, is still a niche with risks but has interesting properties in terms of efficiency, transparency, accessibility, and composability and could contribute to a more robust financial infrastructure. Lüssem, Aziz, and Frías (2023), by contrast, stress that decentralization is not an either-or but a spectrum, and that the actual degree depends on design and market forces. Zukowski (2026) examined 52 protocols and measured the concentration of voting rights with the Herfindahl-Hirschman Index, the same measure that The Big Four uses for the audit market. According to his analysis, what determined concentration was how many tokens insiders still hold today, not the distribution at launch.

I consider both readings correct, but on different layers. On the settlement layer of large blockchains, decentralization is real. Further up, with voting rights, interfaces, and data providers, it is often weaker than the name promises. For a user, this means knowing, for each layer, whom they are trusting.

European regulation reflects this blurriness. The MiCA regulation exempts services provided in a fully decentralized manner without intermediaries. Its rules do apply, however, to stablecoins and to providers through which users gain access, as Stablecoins and MiCA describes. How supervision can get to grips with technically complex offerings is discussed in Fintechs and supervision.

The liability test for your business

Most businesses will never use decentralized finance themselves. They still encounter it: as an interest offer for surplus liquidity, as a customer's payment channel, or as an idea within the team. From the layer model, I derive a test that I call the liability test.

1. Who is liable if something goes wrong?

   For each layer, name a person or company that can be held to account in case of damage. If there is nobody, the business bears the risk entirely.

2. Where does the return come from?

   Explain in one sentence who pays the interest and why. If you cannot, the return is the payment for a risk you do not know.

3. Which building blocks are attached?

   List the protocols, stablecoins, and data providers on which the offer depends. Each is a separate point of failure.

4. Which obligations arise?

   Clarify with your tax adviser and legal counsel which record-keeping and due diligence obligations arise, including under the German Money Laundering Act, as Money laundering obligations describes.

For business assets, the test is clear in most cases: the money with which a business pays salaries and suppliers does not belong in applications without liability. What to consider when holding crypto assets is described in Bitcoin on the balance sheet, and how Bitcoin developed from an experiment into a financial product in Bitcoin in fifteen years.

Conclusion: without banks, but not without trust

To the guiding question: without banks, decentralized finance delivers token swaps, overcollateralized loans, and remarkable transparency about holdings. What does not work are unsecured loans, a reliable link to the real world, and protection against mistakes or attacks. Schär's layer model shows that trust does not disappear in the process but passes to code, data providers, stablecoin issuers, and holders of voting rights. The hacking figures show how expensive mistakes at these points can become.

For a business, the conclusion is clear: decentralized finance is an interesting field for understanding how financial services might be built in the future. For the money that carries the business, it is no substitute for a bank, because the question of liability remains open.

• For every offer with an unusually high interest rate, go through the liability test in writing.
• Decide that business liquidity is not invested in applications without a liable provider.
• Process crypto payments only through licensed providers and convert them into euros immediately.
• Involve the tax adviser before every decision. This article is not investment advice.