What Is DeFi? Decentralised Finance Explained Simply

When you send money through a bank, the bank keeps the records, holds the funds and decides whether to approve your request. DeFi asks a different question: what if software did those jobs instead? That's the idea behind decentralised finance.

I've drawn on ethereum.org's DeFi guide and the FCA's crypto warnings for this explainer. It's general education, not financial advice, and I'm not recommending that you use any DeFi service.

DeFi meaning: finance run by smart contracts

DeFi is short for decentralised finance. ethereum.org describes it as "an open and global financial system built for the internet age". It lets people lend, borrow, save, invest and trade without traditional intermediaries.

The work banks and similar institutions would normally handle is done by smart contracts, which are programs running on Ethereum. If that term is new, see my guide to smart contracts.

DeFi compared with traditional finance

Area	DeFi (per ethereum.org)	Traditional finance
Custody	You hold your own funds	Companies hold your money, so you trust them
Access	Anyone with an internet connection	Usually needs an application
Speed and hours	Transfers can settle in minutes, markets run continuously	Transfers can take days, and markets close
Transparency	Anyone can inspect the code and data	Little visibility into operations
Privacy	Activity is pseudonymous	Closely tied to your identity

What you can do in DeFi

• Lending and borrowing. ethereum.org gives the example of depositing a stablecoin into a lending protocol and receiving a token that grows as interest accrues. Borrowers typically put up collateral instead of facing credit checks.
• Decentralised exchanges. These let you swap tokens at any time without giving up control of your assets.
• Stablecoins. Tokens designed to stay close to the value of traditional money.
• Other uses. ethereum.org also covers streaming payments, crowdfunding, decentralised insurance and flash loans, which are uncollateralised loans that must be repaid within the same transaction.

Stablecoins appear in almost every DeFi example, so understanding stablecoins is a good first step.

The risks of DeFi that ethereum.org mentions

• Software flaws. Ethereum products, like any software, can have bugs and exploits.
• Centralised platforms. Exchanges are targets for hackers, and assets deposited there are at risk.
• Reliance on code reviewers. Users currently depend on technically skilled community members who can read contract code.
• Volatility. The value of ETH can change a lot, which is why stablecoins are often used.

The FCA adds that crypto is high risk and speculative, that you should be prepared to lose all the money you put in, and that crypto activity isn't regulated yet in the UK. It also says it's highly unlikely you'll be covered by the Financial Services Compensation Scheme.

DeFi and who decides what happens

Many DeFi projects are governed by their communities, often as a DAO, where token holders vote on changes. That can feel more open than a company board, but it also means decisions can be influenced by whoever holds the most tokens.

Staying cautious around DeFi scams

Because anyone can launch a token, DeFi is where many scams begin. ethereum.org's security guidance says giveaways are always scams and that you should never share your recovery phrase. Be careful with approvals, too, because unlimited spend limits could let a contract drain your wallet.

A simple example of how lending works in DeFi

ethereum.org walks through a lending example that shows the idea in action. Someone deposits a stablecoin into a lending protocol and receives a token representing their deposit. That token grows as interest accrues, and borrowers typically put up collateral instead of going through a credit check. Software holds the collateral and enforces the rules, so there's no loan officer.

This is also the weak spot. If the code has a bug, or the collateral rules fail, no-one at a bank is there to step in. That's the trade-off behind the whole idea.

Questions to ask before using any DeFi app

1. Has the code been reviewed? ethereum.org notes that users currently rely on skilled community members who can read smart contract code.
2. Who holds my funds at each step? Your own wallet, a smart contract or a centralised exchange each carry different risks.
3. What am I approving? Unlimited spend limits could let a contract drain your wallet.
4. Does the offer sound too good to be true? The FCA says if it does, it probably is.
5. What happens if it fails? The FCA says there's no safety net in the UK if things go wrong.

If you can't answer most of those, that's your answer. Reading before you click is the cheapest protection there is in this space.

Writing about decentralised finance

DeFi writing is full of jargon, and readers value anyone who explains it plainly. If you cover the topic, you may want a wider audience for your articles.

For writers working on decentralised finance topics, this page lists blockchain publications that take outside articles.

Frequently asked questions

What does DeFi stand for?

It stands for decentralised finance. ethereum.org describes it as an open and global financial system, where smart contracts handle jobs banks would otherwise do.

Do I need a bank to use DeFi?

No. ethereum.org says DeFi is open to anyone with an internet connection and that you hold your own funds. That also means you're responsible for protecting them.

What is a flash loan?

ethereum.org describes it as an uncollateralised loan that must be repaid within the same transaction.

Is DeFi risk-free?

No. ethereum.org mentions software bugs, exploits and reliance on people who can read the code, and the FCA calls crypto high risk and speculative.

Is DeFi regulated in the UK?

The FCA says crypto activity isn't regulated yet in the UK and there's no safety net if things go wrong. Check its guidance before using any service.