What Is DeFi? Decentralised Finance Explained

What is DeFi?

Decentralised finance (DeFi) means financial services such as lending, borrowing, trading and payments that run as programs on a blockchain instead of through a bank or broker.

These programs are called smart contracts. They hold the funds and apply the rules automatically. Users connect a self-custody crypto wallet and sign each transaction. On many networks they also pay gas fees for each transaction.

Formal definition

A DeFi protocol is a set of smart contracts on a public blockchain with these properties:

Non-custodial. Users keep control of their assets until a contract executes.
Permissionless. Anyone with a wallet can use it, without an account approval step.
Transparent. The code and every transaction can be read on-chain.
Composable. Other contracts can call it, so protocols can be built on top of each other.

Worked example: a DeFi loan (hypothetical)

Assume a lending protocol that accepts ether as collateral and lends a stablecoin, a token designed to track a fiat currency such as the US dollar.

Ali deposits ether into the lending contract.
The contract lets him borrow stablecoins worth less than his collateral. The protocol's rules set the maximum share of the collateral value he can borrow.
A price feed, called an oracle, keeps reporting the market price of ether to the contract.
If ether falls and the collateral value drops below the protocol's liquidation threshold, the contract allows other users to repay part of the loan and take some of Ali's ether at a discount. This is a liquidation.
If ether holds its value, Ali repays the loan plus interest and withdraws his ether.

No loan officer approves or reviews any of these steps. The code applies them. If the code has a bug or the oracle reports a wrong price, losses can happen just as automatically.

Where you see the term

Crypto news and research reports. They often report "total value locked" (TVL), the value of assets deposited in DeFi contracts. They also report hacks and exploits.
Wallet apps and exchanges. These have sections for staking, swaps or "earn" products. Some of these are DeFi and some are custodial services that only use the label.
Central bank and regulator papers. These compare DeFi with traditional clearing and settlement and with a CBDC.

Crypto CFDs at a broker such as Exness are price contracts with the broker as counterparty. They are not DeFi. See Crypto CFDs for how those work.

Edge cases for experienced readers

Decentralised in name only. Admin keys, upgradeable contracts or a small group of governance-token holders can change the rules or freeze funds.
Centralised parts. A website front end can block users even when the contract itself is open. Fiat-backed stablecoins depend on a custodian holding reserves.
Flash loans. These are loans borrowed and repaid within the same transaction, with no collateral. They are used for arbitrage and also in exploits.
Oracle risk. A manipulated or delayed price feed can trigger wrong liquidations.
No recourse. There is usually no central counterparty, deposit protection or complaints body.

DeFi tokens can lose value fast. Borrowing against volatile collateral adds liquidation risk on top of that. Rules on crypto assets in Pakistan are a separate question. Check the current position of Pakistani regulators before you use any service. Read more in Regulation and Safety and Risk management.

Blockchain · Altcoin · Crypto wallet · Gas fees · Collateral · Derivatives · Fiat money · CBDC · Trading glossary

Frequent questions

What does DeFi mean in crypto?

It means financial services run by smart contracts on a blockchain, used directly from a wallet without a bank or broker in the middle.

Is DeFi the same as a crypto exchange?

No. A centralised exchange holds your funds in custody. A decentralised exchange is a smart contract that you trade with from your own wallet.

Is DeFi safe?

It carries specific risks: code bugs, hacks, oracle failures, liquidations and no legal recourse. You can lose part or all of what you deposit.

Is DeFi halal?

Scholars differ, especially on interest-bearing lending. See Islamic finance for the principles involved.