What is DeFi? Decentralised finance explained simply

What DeFi means and what it is used for

What is DeFi? It stands for decentralised finance, a group of lending, trading and savings tools that operate on public blockchains, not through banks or brokers. Instead of a middleman, you have smart contracts: programs running on a blockchain, carrying out rules they can’t change.

People use DeFi to lend or borrow funds, trade one token for another, or provide liquidity to a pool and collect some of the trading fees. Some protocols also give extra rewards much like staking does; see crypto staking for more detail about proof-of-stake rewards.

How DeFi apps connect to your wallet

You'll use most DeFi apps through your browser or on your phone, linking up a self-custody wallet (where you control the private keys). Every transaction needs you to give permission in your own wallet, and the money flows from you to the app's smart contract, not to a business account.

Since there's no company running things, DeFi apps commonly exist across multiple blockchains, and your wallet must connect to the right one. Switching assets between networks? That uses a crypto bridge and brings extra risk. If you want to see how custody differs, read about CEX vs DEX.

The main risks of DeFi before you deposit

There might be no bank, but that does not mean no risks. Crypto's price can swing sharply, and you could lose money on a loan, as a borrower or lender, or by supplying liquidity. The main risks are:

Smart contract bugs: an error in the code lets someone steal funds, even if there was an audit.
Liquidations: posted collateral goes up for sale automatically if it drops enough in value, so the system can cover the debt.
Impermanent loss: liquidity providers may end up with less value than if they had simply held their coins, if pool prices diverge.
Scams and fake front ends: a lookalike website may try to trick you into signing away your tokens.

Most countries are still working out regulations for DeFi, and you usually will not get the sort of deposit protection that covers a bank account.

Worked example: a loan that gets liquidated

Imagine a lending app where a loan gets liquidated if your collateral drops under 110 percent of what you borrowed. Say you post collateral and then borrow 500 euros’ worth of another asset. When your collateral reaches 540 euros, the coverage ratio slips to 108 percent, so you pass the liquidation point. Each protocol sets different terms, and the figures here are for demonstration only.

Frequently asked questions

Do you need a bank account to use DeFi?

Usually, you don't. DeFi applications use your crypto wallet, not your bank account, for access and transactions. But to turn crypto into euros or top up your balance, you’ll often need an exchange or some other on-ramp, which connects back to banking. There are country differences here, so check the local rules first.

Is DeFi safer than using a centralised exchange?

No, neither is always safer. In DeFi, you never hand assets to a company, so the counterparty risk is lower, but you do face new risks: smart contract flaws, key loss, or being scammed. Centralised exchanges bring the risk that the company might fail or freeze your funds. The models work differently, so make sure you understand both before you choose where to send your money.