Decentralized Finance Definition

Decentralized finance, often shortened to DeFi, is a catch-all term for financial services that run on public blockchains. Instead of a single company holding your funds and approving transactions, software runs the rules and moves assets between users directly. Most DeFi activity started on Ethereum and later spread to other blockchains.

Core idea and traits

DeFi aims to make finance open to anyone with an internet connection. Services are permissionless, so you do not apply for an account, and activity is transparent because transactions live on a public ledger. Interactions are peer-to-peer and typically pseudonymous.

How it works under the hood

DeFi apps rely on smart contracts, which are programs stored on a blockchain. When preset conditions are met, the contract executes exactly as written. This setup removes the need for a central operator and lets people transact with one another by interacting with the contract’s interface. Ethereum popularized this model, and many prominent DeFi protocols still run there.

What people use it for

A wide range of services exists in DeFi. Common examples include:

• Lending and borrowing with crypto posted as collateral
• Decentralized exchanges for trading tokens
• Stablecoins are used for payments or hedging against volatility
• Staking, yield farming, and other ways to earn on holdings
• Insurance-like products and derivatives for hedging and speculation

These categories mirror traditional finance but operate through code instead of intermediaries. 

Access and participation

Most users start with a crypto wallet, add funds, and connect that wallet to a DeFi app in their browser or mobile device. From there, they approve transactions that the app proposes, and the blockchain records each step. Because the services are open, there is no paperwork to open an account.

Benefits users point to

People turn to DeFi for always-on markets, faster settlement, and fewer gatekeepers. Funds can move between apps quickly, and anyone can inspect the transaction history on-chain. Many users also prefer holding their own keys, since that keeps control of assets on their side rather than with a custodian.

Risks and trade-offs

DeFi comes with real risks. Crypto prices can swing sharply. Smart contracts can have bugs or economic design flaws. Network fees change with demand and can make active trading costly. Users are also responsible for managing keys and keeping their own records, including taxes, since rules differ by region. Finally, regulators continue to evaluate how these services fit into existing frameworks.

Key terms at a glance

• dApp: A decentralized application that lets you use a smart contract through a simple interface.
• DEX: A decentralized exchange for swapping tokens directly with other users through liquidity pools.
• AMM: An automated market maker. It prices trades with a formula instead of an order book. 
• Liquidity pool: A pool of tokens locked in a smart contract that powers trading or lending.
• Stablecoin: A crypto asset designed to hold a steady value, often used for payments and settlement in DeFi apps.

DeFi vs centralized finance at a glance

Traditional banks and brokers act as middlemen and can require identity checks or limit access to services. DeFi removes that central operator and replaces it with open-source code, a wallet, and a network of validators. Availability is global and runs around the clock, but the user takes on more responsibility and risk.