DeFi is short for "decentralized finance". Behind the term lies a set of financial services that operate without a bank, broker or any other intermediary. The role of the "clerk" is played by a computer program stored on a blockchain, most often Ethereum. Such a program, called a smart contract, executes predefined rules on its own: it accepts a deposit, calculates interest or swaps one cryptocurrency for another. Everything happens automatically and is visible in a public ledger. In recent years DeFi has grown into a sector worth billions of dollars, and it is still changing fast.
How it works in practice
DeFi is built on open source code and public networks. Anyone with internet access and their own crypto wallet can use the same services, without opening an account and without an institution's permission. Interest rates and fees are usually set algorithmically, depending on how many users want to borrow and how many want to lend.
The most common use cases are:
- lending: you deposit cryptocurrencies as collateral and borrow other assets, with no credit check,
- trading: decentralized exchanges, DEXs for short, let you swap one token for another directly from your wallet,
- saving: you make your funds available to other network participants and earn interest in return.
A large share of this activity has moved in recent years to cheaper layer 2 networks, which has made fees significantly lower. Another important feature of DeFi is that individual services can be combined like building blocks. Funds earned in one place can be used immediately in another, without asking anyone for permission. This freedom speeds up the creation of new solutions, but it also means that trouble in one component can drag others down with it.
What to keep in mind
The convenience and accessibility of DeFi come with risks worth learning about in advance:
- bugs in the code: a smart contract may contain a vulnerability that an attacker can exploit,
- volatility: the value of your collateral can drop sharply, and then your loan is automatically closed at a loss,
- no safety net: there is no deposit insurance and no hotline that can reverse a mistaken transfer,
- scams: some projects are created solely to collect funds and disappear,
- responsibility on your side: you are the one guarding the keys and approving every operation yourself.
In DeFi you are the customer and your own bank at the same time, which means complete freedom and complete responsibility.
Decentralized finance shows that many banking services can be recreated in code: transparently and without an intermediary. It is still a young and experimental field, though. Before you deposit real funds, study exactly how a given platform works and what risks it carries. This article is educational content, not investment advice.