What is DeFi? DeFi, short for decentralized finance, is a set of financial services such as trading, lending and borrowing that run as programs called smart contracts on a blockchain, so that you use them from your own crypto wallet instead of opening an account with a bank or a broker. The idea is attractive: open access, transparent rules and no intermediary taking a cut. The price is that you carry responsibilities a bank normally carries for you, and that mistakes, bugs and scams can be costly and hard to undo. This guide explains how it works, what you can do with it and where the risks sit.
In brief
- DeFi replaces the intermediary of a financial service with a smart contract, a program that runs by itself on a blockchain, and you use it through your own wallet.
- The best-known uses are swapping tokens on decentralized exchanges, lending and borrowing against collateral, and providing liquidity to earn fees.
- Supervisors note that DeFi is less decentralized than advertised, because decisions are still taken by a small group, and that it reproduces many weaknesses of traditional finance.
- The main risks are bugs in smart contracts, risky approvals, scams and fake platforms, sharp price moves, liquidation and the lack of anyone to call when something goes wrong.
- A very high advertised yield usually points to a higher risk, not to a better deal, so a beginner is better off learning with a small amount.
In this article · 12 min read
What is DeFi, in one sentence
DeFi is an umbrella term for financial services offered by automated protocols on public blockchains, without a traditional intermediary in the middle. The Bank for International Settlements (BIS), in its working paper "The Technology of Decentralized Finance (DeFi)" of 19 January 2023, describes it as a financial paradigm that uses distributed ledger technology to offer services such as lending, investing or exchanging crypto-assets without relying on a centralized intermediary. Instead of dealing with a counterparty, users interact with software that pools the resources of other users. ethereum.org presents DeFi as an open, global alternative to the existing financial system, with products to borrow, save, invest and trade.
A few words you will meet below. A blockchain is a shared ledger that many computers keep in sync. A smart contract is code stored on that ledger that carries out agreed rules automatically. A decentralized application (DApp) is a service built from such contracts. A wallet is the app or device that holds the keys to your crypto. And centralized finance (CeFi) is the usual system of banks, brokers and exchanges that run on company servers.
How DeFi works, step by step
The details change from one platform to another, but most DeFi services follow the same path:
- You hold a wallet. It is software or a hardware device that stores your keys. Whoever has the keys controls the funds, so the seed phrase that backs them up matters. Our guides on the seed phrase and on the hardware wallet explain how to protect it.
- You connect to a platform. In most cases you open a website and connect your wallet. The site is only a door: the rules live in the smart contracts behind it.
- You give a permission. The first time, the wallet asks you to approve the contract to use a given token. This is a delicate moment, and we come back to it below.
- You sign the transaction. The contract executes the rules, for example a swap or a deposit. You pay a network fee, often called gas, to the blockchain.
- The result is recorded publicly. Anyone can see the transaction on the blockchain, which is part of the transparency DeFi talks about.
What you can do with DeFi
The BIS lists four main categories of DeFi protocols. In plain words:
- Decentralized exchanges (DEXs). You swap one token for another against a pool of tokens, without a company holding your funds. We explain this in detail in our guide to the decentralized exchange.
- Lending and borrowing. A lender deposits tokens in a protocol and earns interest. A borrower first posts collateral, usually worth more than the loan, as the Congressional Research Service (CRS) notes in its overview of decentralized finance of 16 March 2026. If the collateral loses too much value, part of it is sold automatically to repay the debt.
- Liquidity provision. People deposit a pair of tokens into a pool so that others can trade against it, and receive a share of the fees. The CRS adds that this fee is meant to compensate liquidity providers for the fact that their pair may be worth less when they withdraw it.
- Derivatives and aggregators. Some protocols offer leveraged positions, and others route your order to the best price among several platforms.
Many of these services use stablecoins, tokens designed to hold a fixed value against a currency such as the US dollar. The BIS, in its Quarterly Review of December 2021, puts stablecoins at the centre of the ecosystem, together with the trading, lending and investment protocols. If you are not sure what they are, read our guide to stablecoins.
What is DeFi worth today? The numbers
A common measure of the size of DeFi is the total value locked (TVL), the value of the assets deposited in its protocols. According to the CRS, TVL was about 98 billion US dollars across all blockchains as of March 2026. It had reached nearly 180 billion in late 2021 before falling to below 40 billion. The same report puts about 56 billion on the Ethereum network, about 54 billion in lending protocols, about 27 billion in Aave, the largest lending protocol, and about 3.1 billion in Uniswap, the largest DEX by volume.
The segments overlap, so do not add them up. TVL is also only one yardstick: it moves with token prices and says nothing about how safe a given protocol is.
DeFi and traditional finance: the differences
| DeFi | Traditional finance (CeFi) | |
|---|---|---|
| Who runs the service | Smart contracts, often governed by a community or a small team | A company: a bank, a broker, an exchange |
| How you get in | A wallet and an internet connection | An account, usually with identity checks |
| Who holds your assets | You, through your keys | The institution, in your account |
| If something goes wrong | Often no support and no way to reverse a transaction | A support desk, a complaints procedure, sometimes a protection scheme |
| Main risks | Code bugs, bad approvals, scams, volatility | Failure of the institution, fees, limits on access |
Neither side is better in every situation. In our experience, most newcomers are drawn to the freedom of DeFi and underestimate the responsibility that comes with it.
DeFi explained: what is it and will it replace banks? (Euronews) (in English)
The risks of DeFi
DeFi is young, and the people who study it are cautious. The Financial Stability Board (FSB), in its report on DeFi of 16 February 2023, found that DeFi does not differ substantially from traditional finance in the functions it performs, and that it inherits and may amplify its vulnerabilities: operational fragilities, mismatches between how quickly assets can be sold and when liabilities fall due, leverage and interconnectedness. The BIS authors of the December 2021 Quarterly Review add that these vulnerabilities can be severe because of high leverage, liquidity mismatches, built-in interconnectedness and the absence of shock absorbers such as banks.
In practice, the risks a user meets are these:
- Smart contract risk. A bug or an attack on a contract can drain the funds it holds. Open code can be audited, but an audit is not a guarantee.
- Blockchain or protocol risk. The network the platform runs on can fail, and the project can simply be abandoned.
- The approval signature. Signing a permission for a fake or malicious platform can let it empty your wallet. Check the address of the site before you connect, and read what you authorize.
- Scams and clones. Fake websites, fake tokens and promises of easy yields are common. Our guide to crypto scams lists the usual patterns.
- Price and liquidation risk. Prices can move fast, and a loan backed by volatile collateral can be liquidated automatically.
- Impermanent loss. When you provide liquidity to a pool of volatile tokens, you can end up with less value than if you had simply held the two tokens.
- No safety net. There is usually no support desk, and a transaction signed by mistake is usually final.
"Decentralized" is a spectrum
The BIS speaks of a "decentralisation illusion" in DeFi: some form of centralisation is inevitable, because someone has to take strategic and operational decisions, and structural features of the system favour a concentration of power. A Banco de España article published on 11 July 2023 reaches a similar conclusion: the effective degree of decentralization is lower than advertised, the real benefits are limited, and the potential risks are considerable. The practical lesson is to ask, for each platform, who can change the rules.
John Bax's view
In Cryptocurrency Investing, John Bax devotes a chapter to DeFi and is cautious about two points. On yield, he notes that DeFi is often a hunt for the highest annual percentage yield (APY, the yearly return including reinvested interest), and warns that the more exotic the protocol, the higher the APY offered and the higher the risk of losing everything; the younger and less known a project is, the less information you can find and the greater the risk of using it. On the approval, he calls the first permission you sign to a platform a delicate moment, and gives three rules: make sure it is the right platform, use only platforms you know and have studied, and double-check what you authorize. If you see any danger, do not sign. He also prefers a hardware wallet for larger amounts. These are his views as an author, not advice for your situation.
How to start with DeFi, step by step
- Learn before you deposit. Read about wallets, seed phrases and scams first. Our guide on how to buy cryptocurrency safely is a good first step.
- Choose a wallet and secure it. Write the seed phrase on paper, keep it offline and never type it into a website.
- Start with a small amount. Use only money you can afford to lose, and treat the first transactions as practice.
- Pick established platforms. Prefer services with a long record, open code and public audits, and check the address from an independent source.
- Read every permission. If a request asks for more than the action needs, stop.
- Do not chase the highest yield. Understand where a return comes from before you accept it.
Checklist before your first DeFi transaction
- I know what a smart contract, a wallet and a seed phrase are, and my seed phrase is stored offline.
- I checked the platform's address and I know what I am authorizing.
- I am using an amount I can afford to lose, and I know nothing here is guaranteed.
Where it fits
DeFi is one corner of crypto, and it suits people who want to understand how the technology works and accept its risks. If you would rather build a solid base first, our guide on how to invest in crypto shows where DeFi sits among the other choices. John Bax's book Cryptocurrency Investing covers decentralized finance, wallets and risk in a chapter written for beginners.
Crypto Go Bot is a different tool: it trades on your own Kraken account, with take profit and stop loss placed on Kraken, and it is not a DeFi application. Losses remain possible with any trading tool.
Who it is for
DeFi suits people who are curious about the technology and ready to take responsibility for their own security.
- Curious beginner: someone who wants to understand how swapping, lending and wallets work can try a very small amount to learn, as long as the money is not needed elsewhere.
- Long-term crypto holder: someone who already keeps coins in a hardware wallet can use DeFi occasionally, with a small share of the holdings and a clear idea of the risks of each protocol.
- Careful saver: someone who wonders whether a platform can beat a savings account learns here why a high advertised yield usually comes with a higher risk.
Key terms
- Smart contract: a program stored on a blockchain that carries out agreed rules automatically.
- Wallet: the app or device that holds the keys to your crypto and lets you sign transactions.
- Total value locked (TVL): the value of the assets deposited in DeFi protocols, a common measure of size.
- Liquidity pool: a stock of two or more tokens in a smart contract that traders swap against.
- Impermanent loss: the loss a liquidity provider can face when the prices of the pooled tokens change compared with simply holding them.
- Annual percentage yield (APY): the yearly return including the effect of reinvesting the interest earned.
Frequently asked questions
What is DeFi in simple words?
DeFi is a set of financial services, such as trading and lending, that run on smart contracts instead of a company. You use them from your own wallet, and you are responsible for your keys and your choices.
Is DeFi safe?
It carries real risks: bugs in contracts, scams, sharp price moves and the lack of customer support. Careful habits reduce some of them, but nothing removes them completely.
What is the difference between DeFi and a centralized exchange?
On a centralized exchange a company holds your assets and matches orders. In DeFi you keep your assets in your wallet and a smart contract carries out the trade, which removes one kind of risk and adds others.
Can I lose all my money in DeFi?
Yes, it is possible, for example through a hack, a fake platform, a liquidation or a signature you should not have given. This is why beginners are advised to start small and to use only money they can afford to lose.
What does a high APY mean in DeFi?
It means the protocol advertises a high yearly return, but the figure can change quickly and often reflects a higher risk. Ask where the return comes from before you rely on it.
Is DeFi really decentralized?
Often only in part. Researchers at the BIS and other institutions point out that governance and power tend to concentrate in a few hands, so it helps to ask who can change the rules of a platform.
Sources
- Wikipedia, Decentralized finance
- BIS, The Technology of Decentralized Finance (DeFi), Working Paper No 1066, 19 January 2023
- BIS, DeFi risks and the decentralisation illusion, Quarterly Review, 6 December 2021
- FSB, The Financial Stability Risks of Decentralised Finance, 16 February 2023
- Congressional Research Service, An Overview of Decentralized Finance (DeFi), 16 March 2026
- Banco de España, Las finanzas descentralizadas o los criptoactivos de última generación, Boletín Económico, 11 July 2023
- ethereum.org, Decentralized finance (DeFi)
- Euronews, DeFi explained: what is decentralised finance and could it be a death sentence for banks?, 7 February 2022
