Its the entirety of Pep's philosophy and it works so well because of overloads.
You have a standard back 4 and 2 dms positioned in green and the way Pep attacks as red you get.
-wg-fb-mf-cb-cb-st-fb-wg-
----fb---dm--dm--dm---mf---
In the case of current City across the front that's Grealish, Bernardo/Gundogan, Foden, Jesus across the top. With Cancelo, Rodri, and KDB just behind. The overloads between around the opposition fullback are clear to see and while its usually 4 vs 3 against at the back, its why ball hogging and denying the counter is so important. You are outnumbered and even when teams play with essentially another cb or midfielder coming deep which they mostly do. Its still 7 v 7 and the team without the ball has to be switch on for 90 minutes. One mistake, one person gets beat or caught out of position and the overload is always on. Pep will also always leave City a man short at the back, if there is another green in that little space, Kyle Walker or Laporte will also pop up in there. You will always end up defending with one of the fullbacks overloaded and a man down vs City, always. Its why we are so vulnerable to be beaten with 1 pass ala the champions league final. Pep essentially makes sure there are at least 14-15 players in the final 3rd at all times.
Liverpool essentially do the same but there fullbacks get where Cities wingers are, their wingers where Cities mf and st are, their striker slightly further forward than Rodri in the above and their midfielders pretty much where Cities lfb, and right sided mf are. Its brave to a fault and Liverpool have essentially gone back to heavy metal football this season but despite Liverpool being more direct against packed defences, or 6/7 men back, both teams essentially occupy the same positions and make the same runs. Big difference being Salah in particular doesn't look for cutbacks as often as he's so good he can make space and finish more often than not.
As for how to defend it, you defend it with bravery instead of cowardice most teams show. First off, you push wingers right up and limit the fullbacks getting involved ala Southampton did to City, or Chelsea in the CL final, you limit their numbers and take away the passes they can usually play blind because the extra players aren't there. Chelsea did this really well in the CL final with Mount and Werner in particular and with 2 attacker pinned back and Chelsea's 3 cb and midfield sitting relatively tight City couldn't play their common patterns, rhythm was broken and were incredibly toothless. Chelsea were extremely quick in transition and exploited Cities dm pushing up Gundogan in this case for the pass through for Havertz winner, running from out where the fullback was to inside with a big hole in midfield where a dm should be sitting. In comparison in the league game this season they sat 5 defenders back kept the midfield back and allowed Cities fullbacks the freedom of the bridge till they went behind and while the goal wasn't a cut back it came from pretty much the same overloads.