DeFi is the name given to financial applications built on blockchain, usually Ethereum or other compatible networks, that replicate traditional banking services (lending, currency exchange, interest-bearing savings) through smart contracts instead of banks or brokers.
What sets it apart from traditional finance
- No intermediary: the rules are enforced by the smart contract's code, visible and auditable by anyone, rather than by an entity deciding case by case.
- Open access: anyone with a wallet can use these protocols, with no account opening or identity verification in most cases.
- Composability: DeFi protocols can be combined with each other like Lego pieces (for example, using the token you receive for providing liquidity on a DEX as collateral in another lending protocol).
The risks don't disappear, they change
Instead of the risk of a bank going under, in DeFi the main risk is that the smart contract has an exploitable security flaw, that the protocol depends on a price oracle that can be manipulated, or the inherent volatility of the cryptocurrencies used as collateral.