What DeFi is
Financial services implemented as programs rather than companies. The same functions as a bank, with different failure modes and no closing time.
Decentralised finance rebuilds familiar financial functions — exchange, lending, derivatives, market making — as smart contracts that anyone can use without an account, an application, or permission.
What it actually consists of
- Exchanges that hold no customer funds and match trades against a pool rather than an order book. See automated market makers.
- Lending markets where deposits and borrowings are pooled and rates move algorithmically with utilisation. See lending protocols.
- Stablecoins, the settlement asset for nearly all of it.
- Derivatives — mostly perpetual futures, offering leverage without an expiry date.
- Yield products that route deposits between the above automatically.
What is genuinely different
- No account. A wallet address is sufficient. There is no approval, no minimum, no jurisdiction check at the protocol level.
- Continuous operation. No settlement cycles, no market hours, no holidays.
- Composability. Protocols call one another. A deposit token from one can serve as collateral in another, which can be wrapped by a third. This is powerful and it is the mechanism by which one failure propagates.
- Visible positions. Collateral ratios and liquidation thresholds are public, so stress is observable in real time rather than reported quarterly.
What is not different
A bank performs credit assessment, maturity transformation, and loss absorption. DeFi replaces credit assessment with over-collateralisation, which works and is capital-inefficient. It replaces loss absorption with automatic liquidation, which works until markets move faster than liquidators can act. The functions did not disappear; they were reimplemented with different tolerances.
Over-collateralisation
Because a contract cannot assess your creditworthiness or pursue you for a shortfall, almost all DeFi borrowing requires collateral worth more than the loan. You might deposit $150 of one asset to borrow $100 of another.
This makes an obvious question unavoidable: why borrow less than you already have? The genuine answers are leverage, avoiding a taxable disposal, and obtaining liquidity without selling a position. What it is not is credit in the sense that matters to most households or businesses — and uncollateralised lending without an identity system remains unsolved.
The risks, in order of how often they have cost people money
- Contract exploits. A flaw in the code drains the pool.
- Oracle manipulation. The code is sound; the price it relied on was moved.
- Liquidation cascades. A sharp fall triggers forced sales that push prices further down, triggering more.
- Stablecoin failure. The unit everything is denominated in stops being worth what it claims.
- Governance capture. Whoever controls the upgrade keys or a majority of governance tokens can change the rules.
- Your own mistakes. Wrong network, unlimited approval granted to a malicious contract, a phishing site with a convincing domain.
If a protocol is exploited, the money is gone. There is no regulator to complain to, no scheme to compensate you, and in most cases no legal entity to sue. Some protocols hold insurance funds or treasuries and have chosen to make users whole. That is a discretionary act by a group of token holders, not an entitlement.