Money · Five minutes
What is DeFi?
Lending, trading and derivatives rebuilt as programs that run on a blockchain. No company holds your money, and no company can help you either.
- CustodyYours, throughout
- LoansOver-collateralised, because there is no identity
- Yield sourcesBorrowers, traders, protocols, treasuries
- RecourseNone
Decentralised finance replaces the institution with a smart contract. The contract holds the funds, the rules are in code anyone can read, and it runs continuously without anyone's permission. You keep custody the whole time, interacting from your own wallet.
The three things that actually exist
Exchanges. Instead of an order book, most decentralised exchanges use a pool of two assets and a formula that sets the price from the ratio between them. Anyone can trade against the pool, and anyone can supply assets to it and earn a share of the fees.
Lending. Deposit an asset and earn interest from borrowers. Borrowers must deposit collateral worth more than they borrow, and if the collateral falls in value the contract sells it automatically. There is no credit assessment because there is no identity, which is why everything is over-collateralised.
Derivatives. Perpetual futures and options, run by contracts, with funding payments between long and short holders to keep the price near the underlying.
The question that filters everything
Where does the yield come from? There are four honest answers: a borrower pays interest, a trader pays a fee, a protocol pays for security, or a government pays a coupon on tokenized treasuries. If none of those describes it, the yield is new tokens being printed, which is dilution advertised as income.
The risks, which are different from a bank
Smart contract risk. A bug lets someone drain the pool. Audits help and do not eliminate it.
Oracle risk. Contracts need outside prices to decide when to liquidate. Manipulate the feed and you can trigger liquidations that should not happen.
Liquidation risk. Your own collateral is sold automatically, at the worst moment, with a penalty.
Impermanent loss. Supply two assets to a trading pool and the pool sells the one that rises. Compared with just holding both, you end up behind, and fees may not cover the gap.
Governance risk. Token holders can change the rules, and voting power is often concentrated.
Who it is for
People who want financial services without an intermediary and accept that there is no deposit insurance, no reversal, no complaints process and no one to call. That is a real trade-off with real advantages, and it is not a savings account with a better rate.
Terms used here
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