What is DeFi?What is DeFi? Decentralized Finance explained

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DeFi stands for Decentralized Finance. In short: financial services without banks. Saving, lending and trading that you'd normally arrange through a bank or exchange run here on open code on a blockchain. No middleman taking a cut, no opening hours, no account application. But also a number of new risks, which we'll go into further down.

Concretely: instead of putting money into a savings account at a bank, you deposit crypto into a smart contract that automatically lends it to someone else and pays you interest. The code is public, anyone can check what's happening.

The difference with "ordinary" crypto: bitcoin gave you control over your money. DeFi goes a step further and gives you control over financial services, without needing a bank.

Almost all DeFi applications run on the Ethereum blockchain. Ethereum is a kind of global computer on which developers can place smart contracts: programs that automatically execute what has been programmed into them, without a human or company being needed.

An example: say you want to lend out 100 euros in ether. You deposit it into a DeFi lending protocol (Aave, for instance). Someone else borrows it from the protocol and pays interest. The smart contract automatically distributes that interest among everyone who has deposited money into the protocol, in proportion to their stake. No bank, no credit assessor, just code.

Smart contracts are open source. Anyone can view the code and build on it. That's why DeFi protocols are also called "money legos": they click together, and you can assemble complex financial products by combining existing blocks.

DeFi isn't a one-app-does-everything. It's an ecosystem of hundreds of protocols for different financial services. The three best known categories:

• Borrowing and lending. Aave, Compound. You deposit crypto and earn interest, or you borrow crypto and pay interest. That does come with extra risks.
• Decentralised exchanges (DEX). Uniswap, Curve. You swap one cryptocurrency directly for another without a central party matching the orders. Smart contracts handle the trading.
• Stablecoins. USDC, DAI. Tokens that peg their value to the US dollar. Handy for anyone who wants to be active in the crypto world but doesn't want the volatility of bitcoin or ether. DAI is fully decentralised (backed by ether in a smart contract); USDC is backed by dollars in a corporate account and is therefore less "decentralised".

DeFi can offer high returns, but the risks are just as high. The three most important ones:

• Smart contract bugs. DeFi protocols are only as secure as their code. A flaw in a smart contract can drain millions of euros, and that has happened more than once. Attackers don't hack the protocol, they find weak links in the "lego tower" of smart contracts.
• No consumer protection. If you lose money through a hack, a bug or a mistake of your own, there's no deposit guarantee and no customer service to reverse it. What's gone stays gone.
• Unpredictable returns. The interest rate you see (sometimes 20% or more) is not a guaranteed annual return. It can halve within a day or turn negative. For classic benchmarks (such as a risk-free return) there is still too little historical data in DeFi.

• Ethereum (ETH), for most DeFi applications on Ethereum.
• Bitcoin (BTC), as a base asset.

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