Decentralized Finance (DeFi) recreates financial services using blockchain technology without traditional intermediaries. Understanding DeFi fundamentals helps evaluate opportunities and risks in this emerging space.
What Is DeFi
Financial services built on blockchain technology. Smart contracts replace banks and brokers. Users maintain custody of their assets. Operates 24/7 without geographic restrictions. Still experimental with significant risks.
Core DeFi Services
Lending and Borrowing
Deposit crypto to earn interest. Borrow against crypto collateral. Rates determined by supply and demand. No credit checks but over-collateralization required. Liquidation risk if collateral value drops.
Decentralized Exchanges (DEXs)
Trade crypto without centralized exchange. Automated market makers provide liquidity. Users trade directly from wallets. Lower counterparty risk but higher complexity. Gas fees affect small trades significantly.
Yield Farming
Maximize returns by moving assets between protocols. Often involves providing liquidity. Higher returns come with higher risks. Complex strategies require significant knowledge. “Rug pulls” and exploits are common risks.
DeFi Risks
Smart contract vulnerabilities can lose all funds. Impermanent loss in liquidity provision. Regulatory uncertainty affects projects. High gas fees on Ethereum network. Protocol failures have occurred repeatedly.
Getting Started Safely
Start with small amounts to learn. Use established protocols with security audits. Understand each protocol before depositing. Never invest more than you can lose. Research thoroughly before any interaction.
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