What is DeFi?

DeFi is short for decentralized finance. It means financial services, such as trading, lending and saving, that are run by software on a blockchain and not by a bank, broker or exchange company. Most of it lives on Ethereum and networks built in a similar way.

How does DeFi work?

The building block is the smart contract, a program stored on a blockchain that carries out set rules automatically. A lending program, for example, holds deposits, sets an interest rate by formula and releases funds when its conditions are met. No employee approves anything.

A person uses DeFi by connecting a crypto wallet to a website and signing transactions. There is usually no account to open and no identity check. The funds stay under the user's own keys until they are sent to a contract.

What can you do with it?

The main uses are:

• Trading. A decentralized exchange lets people swap one token for another against a shared pot of funds called a liquidity pool.
• Lending and borrowing. Depositors earn interest, and borrowers post crypto as collateral to take out loans. See how crypto lending works.
• Earning rewards. People who supply funds to these programs collect fees or newly issued tokens, a practice known as yield farming.
• Holding dollars. Much DeFi activity runs on stablecoins, which are tokens designed to hold a value of one dollar.

How is DeFi different from a bank?

A bank holds your money, knows who you are and can reverse a mistaken payment. It is licensed and supervised, and in many countries deposits carry government-backed insurance.

In DeFi, the code is the counterparty. Anyone with a wallet can use it at any hour, the rules are public, and every transaction is recorded on an open ledger. Supporters say this cuts out middlemen and opens financial services to anyone with an internet connection.

Critics say the picture is less tidy. Many projects are run by a small team that can change the code. Most activity is speculation on crypto prices, not lending to households or businesses. Regulators in several countries are still working out how existing financial rules apply.

What are the risks?

• Code risk. A bug in a smart contract can let an attacker drain it. Money lost this way is rarely recovered.
• Market risk. Collateral can be sold automatically when prices fall, a process called liquidation.
• Scams. Anyone can launch a token or a pool, and some are built to take depositors' money, as in a rug pull.
• No safety net. There is no help desk, no chargeback and no deposit insurance. A transaction sent to the wrong place is usually final.