DeFi: What Is Decentralized Finance and How Does It Work?

Over $105 billion. That’s the amount deposited in decentralized finance protocols in early 2026, according to DefiLlama — more than the GDP of several countries. Yet DeFi remains uncharted territory for the vast majority of savers. Borrowing without a bank, earning yields without a broker, swapping assets without a centralized exchange: what sounded like science fiction ten years ago is now a daily reality for millions of users. In this guide, you’ll discover exactly what DeFi is, how it works, what services it offers and how to take your first steps safely.

What is DeFi (Decentralized Finance)?

DeFi — or Decentralized Finance — refers to the entire ecosystem of financial services that operate without centralized intermediaries (banks, brokers, insurers), powered by automated programs called smart contracts deployed on a blockchain. To understand DeFi, picture your current bank. When you apply for a loan, an advisor reviews your file, a committee approves the request, and the institution takes its cut along the way. DeFi removes all these intermediaries: a smart contract — an autonomous computer program — replaces the advisor, the committee and the bank itself. It enforces the rules automatically, transparently and impartially. The result? Financial services accessible to anyone with a wallet (digital wallet) and an internet connection. No forms to fill out, no waiting periods, no geographic discrimination. A farmer in Kenya and a professional in New York have access to exactly the same tools, under exactly the same conditions. DeFi has primarily developed on Ethereum, which alone accounts for over $99 billion in TVL in 2025. But other blockchains like Solana, Arbitrum and Base also host thriving DeFi ecosystems.

How does DeFi actually work?

DeFi relies on three technological pillars: the blockchain as an immutable public ledger, smart contracts as the automatic execution engine, and wallets as the entry point for users.

Blockchain: the tamper-proof ledger

The blockchain is a shared, decentralized accounting ledger. Every transaction is permanently recorded and verifiable by anyone. No one can modify or delete a record once it has been validated. This property is what makes DeFi possible: you don’t need to trust a third party, because the rules are embedded in the code and the evidence is accessible to all.

Smart contracts: the automated bankers

A smart contract is a program that executes automatically when predefined conditions are met. Think of a vending machine: you insert a coin, press a button, and the product drops. No salesperson involved. In DeFi, the smart contract replaces the banker: it verifies conditions, executes the transaction and distributes funds — without human intervention.

Wallets: your key to entry

To interact with DeFi, you need a wallet (digital wallet) such as MetaMask, Rabby or Ledger. This wallet holds your private keys — the digital equivalent of your bank password — and lets you sign transactions directly with DeFi protocols, without going through an intermediary.

What are the main DeFi services?

The DeFi ecosystem replicates all traditional financial services — lending, borrowing, trading, saving — and invents new ones, such as yield farming and liquidity provision.

Lending and Borrowing

Protocols like Aave and Compound let you lend your cryptocurrencies to earn interest, or borrow by depositing collateral. In practice, if you deposit $1,000 worth of ETH on Aave, you can borrow up to ~$750 in stablecoins while continuing to hold your ETH. No credit score needed, no appointment required.

Decentralized Exchanges (DEX)

DEXs like Uniswap, Curve and Jupiter (Solana) allow you to swap tokens directly between users, without a centralized order book. The mechanism relies on liquidity pools funded by other users (liquidity providers or LPs). In return for their contribution, LPs earn a fee on every trade.

Liquid Staking

Staking involves locking up crypto to help secure a blockchain and receive rewards in return. With liquid staking offered by Lido or Rocket Pool, you stake your ETH while receiving a representative token (stETH, rETH) that you can continue using in other DeFi protocols. Double usage, double opportunity.

Stablecoins

Stablecoins are cryptocurrencies pegged to a fiat currency (usually the US dollar). DAI (MakerDAO) is a decentralized stablecoin generated through an over-collateralization system. USDC and USDT are centralized stablecoins backed by reserves. They serve as the reference currency throughout the DeFi ecosystem.

Yield Farming

Yield farming involves strategically moving your assets between different protocols to maximize returns. You deposit liquidity into a protocol, receive rewards in the form of tokens, then reinvest those tokens elsewhere. This is the principle behind DeFi’s “Money Legos”: protocols stack into one another to create increasingly sophisticated strategies.

What are DeFi’s advantages over traditional finance?

DeFi outperforms traditional finance across five key dimensions: universal accessibility, full transparency, potentially higher yields, protocol composability and the absence of discrimination.

• Universal accessibility : no bank account, proof of income or residency needed. A smartphone and a wallet are enough. Over one billion unbanked people worldwide could theoretically access these services.
• Full transparency : every transaction is visible on-chain, smart contract code is open source and auditable by anyone. No more banking “black boxes.”
• Attractive yields : DeFi interest rates often exceed those of traditional finance (lending 3-8% vs savings accounts 0.5-4%), because there’s no intermediary to pay.
• Composability : DeFi protocols can interact with each other like Lego bricks. You can stake your ETH on Lido, use the stETH received as collateral on Aave, and borrow stablecoins — all in a few clicks.
• Permanent availability : DeFi runs 24/7, 365 days a year. No holidays, no “system downtime,” no closed counters.

What are the risks of DeFi?

DeFi carries significant risks: smart contract vulnerabilities, massive hacks, impermanent loss, rug pulls and technical complexity. In 2025, over $3.4 billion was stolen across the crypto ecosystem.

• Smart contract vulnerabilities : a bug in the code can allow an attacker to drain an entire protocol. Even audited projects aren’t immune: the Bybit hack in February 2025 ($1.5 billion stolen by the Lazarus Group) hit a major player through a flaw in the transaction signing process.
• Hacks and breaches : $3.4 billion stolen in 2025 according to Chainalysis, with a significant portion linked to access control flaws. Individual wallet incidents surged to 158,000 cases affecting 80,000 victims.
• Impermanent loss : liquidity providers on DEXs face temporary losses when token prices in the pool diverge. The higher the volatility, the greater the potential loss.
• Rug pulls and fraudulent projects : some projects are created solely to attract funds before disappearing. An unverified smart contract or a project without an identified team should always raise red flags.
• Technical complexity : a mistake (sending funds to the wrong address, approving a malicious contract) can lead to irreversible loss. There’s no customer service to reverse a blockchain transaction.
• Regulatory risk : evolving regulations (MiCA in Europe, SEC in the United States) could change the rules and impact certain protocols.

How to get started with DeFi safely?

To get started with DeFi without excessive risk, take a progressive approach: install a secure wallet, begin with small amounts on audited protocols and prioritize staking as your first step. Here are the recommended steps for your first foray into DeFi:

1. Install a reliable wallet : MetaMask (browser-based) or Rabby are good choices for beginners. For maximum security, consider a hardware wallet like Ledger.
2. Fund your wallet : buy ETH (or the native crypto of your target blockchain) on a centralized exchange (Coinbase, Binance), then transfer it to your wallet.
3. Start with staking : it’s the simplest and least risky DeFi activity. Head to Lido to stake your ETH and receive stETH in return. Annual yield: approximately 3-4%.
4. Explore gradually : once comfortable with staking, try lending on Aave (depositing stablecoins to earn interest) or a swap on Uniswap.
5. Golden rules : never invest more than you can afford to lose. Always verify that the protocol has been audited (look for audit reports on their website). Never click on suspicious links and never share your seed phrase.

What does the future hold for DeFi?

DeFi’s future is shaped by three major trends: real-world asset tokenization (RWA), institutional adoption and convergence with traditional finance under the MiCA regulatory framework.

Real-World Asset Tokenization (RWA)

DeFi’s next frontier is the real world. RWA (Real World Assets) tokenization brings traditional assets onto the blockchain: government bonds, real estate, stocks. Giants like BlackRock, Franklin Templeton and JPMorgan have already launched tokenized funds. Standard Chartered predicts this market could reach several trillion dollars by 2030.

Institutional adoption

DeFi is no longer a playground exclusively for early adopters. Traditional financial institutions are actively exploring these protocols: institutional lending on Aave, treasury management via stablecoins, access to DeFi yields through regulated funds. The line between CeFi (centralized finance) and DeFi is becoming increasingly blurred.

MiCA regulation and its impact

In Europe, the MiCA regulation (Markets in Crypto-Assets) finally provides a clear legal framework for crypto-assets. While “pure” DeFi (fully decentralized protocols) largely remains outside the regulatory perimeter, the bridges between CeFi and DeFi will be increasingly regulated. This legal clarity should paradoxically accelerate adoption by reassuring institutional investors and cautious retail users.