What is DeFi
Definition of DeFi
DeFi (Decentralized Finance) is a decentralized financial system built on blockchain and smart contracts. It provides financial services without centralized intermediaries like banks, exchanges, or insurance companies.
To get a loan in traditional finance, you need to apply to a bank, undergo credit checks, and wait for approval. In DeFi, anyone with collateral can get a loan anytime, without any screening. Code replaces the bank.
The core philosophy of DeFi: "Code is Law" — Rules are specified in code, apply equally to everyone, and no one can arbitrarily change them.
CeFi vs DeFi
CeFi (Centralized Finance)
CeFi is the traditional way where centralized institutions provide financial services. This includes not only traditional banks but also centralized exchanges like Binance and Coinbase.
CeFi Characteristics:
- Institutions hold assets (custody)
- Identity verification (KYC) required
- Services used according to institutional rules
- Assets at risk if institution goes bankrupt (FTX incident)
- Regulatory compliance, legal protection
DeFi (Decentralized Finance)
In DeFi, smart contracts automatically execute financial services.
DeFi Characteristics:
- Users hold their own assets (self-custody)
- No identity verification required (just need a wallet)
- Rules in code apply equally to everyone
- Assets at risk from smart contract bugs
- Regulatory gray area, limited legal protection
Comparison Table
| Aspect | CeFi | DeFi |
|---|---|---|
| Trust | Institutions (banks, exchanges) | Code (smart contracts) |
| Asset Custody | Held by institutions | Held by users |
| Access | KYC required | Anyone with a wallet |
| Operating Hours | Business hours | 24/7/365 |
| Transparency | Limited | Fully public (on-chain) |
| Risks | Institution bankruptcy, fraud | Smart contract bugs, hacks |
| Regulation | Clear | Uncertain |
Core Characteristics of DeFi
1. Permissionless
Anyone can participate without permission. Regardless of nationality, credit score, or asset size, you only need the internet and a wallet.
- Use financial services without a bank account
- Get collateralized loans without credit checks
- Anyone can provide liquidity and earn fees
This is especially revolutionary in regions with low banking access (Africa, Southeast Asia, etc.). With just a smartphone and internet, you can access the global financial system.
2. Transparency
All transactions and smart contract code are public on the blockchain.
- Anyone can verify a protocol's fund size
- All transactions are public (anonymous but traceable)
- Code is public so operations can be verified
- "Don't trust, verify"
You can't know what a bank does with your deposits, but anyone can see a DeFi protocol's fund flows in real-time.
3. Composability
DeFi protocols can connect with each other to create more complex services. This is also called "Money Lego."
Example: In a single transaction
- Deposit ETH in Aave and
- Borrow DAI
- Swap for ETH on Uniswap and
- Deposit again in Aave (leverage)
This entire process executes atomically in one transaction. If any step fails, everything is cancelled. Such complex combinations are possible because all protocols are interoperable on the same blockchain.
4. Self-Sovereignty
Users have complete control over their own assets.
- No one can freeze or seize your funds
- With private keys, you can access assets from anywhere in the world
- Move assets without third-party approval
This is both freedom and responsibility. If you lose your private keys, you permanently lose your assets. There's no password reset like at a bank.
Main DeFi Services
DEX (Decentralized Exchange)
Exchange tokens without a centralized exchange. Uniswap, Curve, and SushiSwap are representative examples. Learn more in How DEXs Work.
Lending
Deposit collateral to borrow other assets, or deposit assets to earn interest. Aave and Compound are representative examples. Learn more in DeFi Lending Structure.
Stablecoins
Tokens pegged to the dollar, etc. USDT, USDC, and DAI exist. They serve as DeFi's reserve currency. Learn more in Types of Stablecoins.
Staking
Deposit tokens and contribute to network security while earning rewards. Learn more in PoS Staking Basics.
Yield Farming
Strategies to maximize returns using multiple protocols. Learn more in Yield Farming Strategies.
Derivatives
Decentralized futures and options trading. dYdX, GMX, and Synthetix exist.
Insurance
Insurance against smart contract hacks. Nexus Mutual exists. Learn more in DeFi Insurance.
History of DeFi
2017: The Beginning
MakerDAO launched the DAI stablecoin, laying the foundation for DeFi. It was the first decentralized system to deposit collateral and issue stablecoins.
2018~2019: Infrastructure Building
Core protocols like Uniswap, Compound, and Aave emerged. There were few users yet, but the technical foundation was established.
2020: DeFi Summer
Compound introduced liquidity mining with the COMP token, triggering explosive growth. TVL (Total Value Locked) surged to billions of dollars. The concept of "yield farming" became popular.
2021: Peak Era
DeFi TVL exceeded $100B. DeFi ecosystems expanded across various chains (BSC, Polygon, Solana, Avalanche, etc.). The combination of NFTs and DeFi also began.
2022: Trials
Major incidents occurred including the Terra/UST collapse and FTX bankruptcy. TVL decreased significantly and the market cooled. However, core protocols survived and continued to develop.
2023~Present: Maturation
New paradigms emerged including restaking (EigenLayer), intents, and chain abstraction. Regulatory discussions intensified and institutional participation increased.
Pros and Cons of DeFi
Advantages
- Accessibility: Anyone can participate. Includes the financially underserved
- Efficiency: Cost reduction by eliminating intermediaries. 24/7 operation
- Transparency: Everything is public on-chain
- Innovation Speed: Rapid development through open source and composability
- Self-Sovereignty: Complete control over assets
Disadvantages
- Complexity: High barrier to entry for average people
- Smart Contract Risk: Code bugs, hacking risks
- Volatility: Liquidation when collateral asset prices crash
- Gas Fees: High fees when Ethereum is congested
- Regulatory Uncertainty: Unclear legal status
- Scams/Rug Pulls: Malicious projects exist
Getting Started with DeFi
To start with DeFi, you need the following:
- Wallet: MetaMask, Rabby, etc. (detailed in Wallets and Self-Custody)
- Gas Cryptocurrency: ETH, SOL, etc. for network fees
- Basic Knowledge: Understanding concepts like smart contracts, approvals, gas
- Caution: Start with small amounts, don't invest in what you don't understand
Warning: DeFi is experimental technology. "Code is law" but code can have bugs. Always understand the risks before investing and only use funds you can afford to lose.
Summary
DeFi is a system that provides financial services without centralized intermediaries using blockchain and smart contracts. Permissionless access, transparency, composability, and self-sovereignty are core characteristics, with various services including DEXs, lending, stablecoins, and staking. Along with revolutionary possibilities, there are downsides like smart contract risks and complexity, requiring sufficient learning and careful approach.
Next article: Wallets and Self-Custody - Protect Your Own Assets