Rather than opening an account, you connect a wallet and interact directly with programs deployed on a blockchain. Those programs are public and can call one another, which is why DeFi is described as composable: a lending market plugs into a trading venue, which plugs into a strategy contract, with nobody signing anything. Composability is the appeal, and when one piece fails it is also the route contagion travels.
The building blocks are surprisingly few. A <a href="/glossary/decentralized-exchange/">decentralised exchange</a> lets people swap tokens against a <a href="/glossary/liquidity-pool/">liquidity pool</a> instead of a named counterparty. Lending protocols take deposits and issue overcollateralised loans, with rates set by how much of the pool is borrowed. Stablecoins, derivatives and automated strategies sit on top. Almost everything else is a recombination of those pieces.
State the risks plainly. Contract code can contain bugs, and a live contract may hold a great deal of money while somebody quietly writes an exploit against it. Price feeds come from oracles that can stall or be manipulated. Borrowing against collateral means forced liquidation if prices move quickly. Supplying assets to a pool exposes you to <a href="/glossary/impermanent-loss/">impermanent loss</a>. Recourse is rare.
Two habits prevent a lot of avoidable damage. First, understand what you are signing, because a token approval can grant a contract open-ended permission to move your balance, and old approvals are worth reviewing. Second, treat headline yields as compensation for risk rather than as free money. When a return sits far above everything else on offer, the interesting question is who is paying it and why.
DeFi Basics and Risks
Key takeaways
- DeFi replaces the institution with code, which removes the gatekeeper and the safety net at the same time.
- Most protocols are recombinations of a few primitives: pooled trading, overcollateralised lending and automated strategies layered on top.
- An unusually high advertised return is a description of risk, not generosity, so find out who funds the payout.
DeFi — frequently asked questions
Is DeFi safer than using an exchange?
It is differently risky. A centralised exchange can freeze accounts, be hacked or fail, but it may also correct an error and often carries some regulatory oversight. DeFi removes that middleman, so nobody can freeze your funds, and nobody can help when a contract is exploited or you approve a malicious transaction. Neither option is safe; they concentrate risk in different places.
Do I need to understand smart contracts to use DeFi?
You do not need to read code, but you should understand what each transaction authorises. The most common beginner losses come from signing approvals on a lookalike site rather than from exotic protocol failures. If you cannot explain in one sentence what a transaction does, and what happens if the price moves against you, that is a good reason to wait.
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