Home›Learn›Crypto›DeFi, explained
DeFi · Crypto
DeFi, explained
Learn what decentralized finance is, how the main tools work, and how to read the terms that show up in crypto coverage.
What decentralized finance means
Decentralized finance, often shortened to DeFi, is a set of financial apps built on blockchains. The goal is to let people borrow, lend, trade, or earn yield using software instead of a traditional bank or brokerage.
In practice, DeFi is not one thing. It is a loose category of apps, blockchains, tokens, and rules that try to recreate familiar financial services in a more open way.
How DeFi uses smart contracts instead of a company middleman
Most DeFi apps run on smart contracts, which are programs stored on a blockchain. A smart contract automatically follows rules written into code, such as moving funds when a trade is made or locking tokens until a loan is repaid.
Because the rules live on-chain, anyone can usually inspect the code and transaction history. That openness is a big part of DeFi’s appeal, but it also means bugs in the code can affect users directly.
How lending and borrowing work in DeFi
DeFi lending platforms let users supply crypto to a pool, then allow other users to borrow from that pool. The lender earns part of the borrower’s interest, while the borrower usually posts collateral to help secure the loan.
Collateral is extra value pledged to back the loan. If the collateral falls below a required level, the system can automatically sell it or close the position, depending on how that protocol is designed.
How trading on automated market makers differs from exchange order books
Many DeFi trades happen on automated market makers, or AMMs. An AMM uses a pool of tokens and a formula to set prices, instead of matching a buyer with a seller through an order book.
An order book is the list of buy and sell offers used by many traditional exchanges and some crypto venues. AMMs can make trading possible at any time, but the price a trader gets can move more when the trade is large or the pool is small.
What yield means in DeFi and why it varies
Yield is the return someone earns for providing capital to a DeFi protocol. It can come from trading fees, borrowing interest, token rewards, or a mix of these sources.
Yields in DeFi can change quickly because they depend on activity, token incentives, and market demand. A high yield is not the same thing as a guaranteed return, and the source of the yield matters as much as the headline number.
What a governance token is
Many DeFi projects have a governance token. This is a token that can give holders voting rights over protocol changes, such as fee settings, upgrades, or how treasury funds are used.
A governance token can also trade like any other crypto asset, so it may have both a voting function and a market price. Those two roles are separate, even though they are often discussed together.
Why liquidity matters so much in DeFi
Liquidity is how easily a token or pool can absorb trades without a big price swing. In DeFi, liquidity often comes from users who deposit assets into pools so other people can trade or borrow against them.
When liquidity is thin, even small trades can move prices more sharply. That is why news about liquidity, volume, or locked value often matters in DeFi coverage.
Common questions
Is DeFi the same as cryptocurrency?
No. Cryptocurrency is the broad category of digital assets, while DeFi is a set of financial services built using those assets and blockchain software. Some DeFi apps use the same tokens that investors also trade as stand-alone crypto assets.
What does TVL mean in DeFi articles?
TVL stands for total value locked. It usually refers to the dollar value of assets deposited into a DeFi protocol. Readers use it as a rough measure of how much capital a protocol is attracting, but it does not tell the whole story.
Why do DeFi users need to understand gas fees?
Gas fees are the network fees paid to use some blockchains. In DeFi, those fees can affect whether a small trade, swap, or lending action is worth doing. Different blockchains and networks can have very different fee structures.
What is impermanent loss?
Impermanent loss is the difference between holding tokens in a liquidity pool and simply holding them in a wallet when prices move. It can happen to people who provide liquidity to AMMs. The loss is called impermanent because it can shrink or disappear if prices move back, but it can become permanent if the position is closed at the wrong time.
Is DeFi regulated the same way everywhere?
No. Rules vary by country and can change over time. Some DeFi activity may fall under existing financial laws, while other parts sit in a gray area, so coverage often depends on the jurisdiction being discussed.