What Is DeFi?
A detailed explanation of how DeFi works, how to get started, and which risks beginners should understand in 2026.
Many people say, “I keep hearing about DeFi lately, but honestly, I do not fully understand what it is.” And that is completely normal. Even if someone tells you that financial services can be used without banks, it is not always immediately clear what exactly changes in practice.
DeFi is a decentralized financial systеm in which the role of banks and intermediaries is performed by programs running on the blockchain. This sector gained major attention in 2020, and by 2026 it continues to expand, including through ecosystems such as Solana and Arbitrum.
In this article, we will break down the basic principles of how DeFi works, its main sectors, the risks involved, the first steps to take, and the current trends that beginners most often encounter.
What Does DeFi Mean? A Simple Definition of Decentralized Finance
DeFi is short for Decentralized Finance.
The word “decentralized” means that control is not concentrated in one central place. In other words, financial services can operate without a central administrator such as a bank, broker, or payment company. Instead, they run on blockchain infrastructure and programmed rules.
What Does It Mean to “rеplace a Bank with a Program”?
In essence, DeFi is a financial systеm in which the tasks that were traditionally performed by a bank are transferred to software.
For example, in the traditional systеm, to get a loan you must go through a bank review process, and the bank itself determines the interest and terms. In DeFi, the role of that “bank” is played by a smart contract—a blockchain-based program that automatically executes predefined rules. As a result, approvals, lending, interest calculations, and other operations take place without human involvement or subjective decisions by staff—strictly according to the logic of the code.
One of the key features of DeFi is that such services can be used from anywhere in the world as long as you have internet access. A bank account is not required, and access to the services is available 24 hours a day, 365 days a year.
Why DeFi Appeared in the First Place: Problems with Traditional Finance
The development of blockchain technology and DeFi was a response to systemic limitations that traditional finance had faced for many years.
5 Limitations of Centralized Finance (CeFi)
The problems of the traditional financial systеm can be broadly divided into five main points:
- High fees
Money transfers and currency exchange are often expensive, and international transfers can take several days. - Limited operating hours
Many financial services are available only during business hours and on weekdays. - Geographic inequality
There are still around 1.4 billion people in the world who do not have access to a bank account. - Lack of transparency
Users cannot see in real time how financial institutions manage assets within the systеm. - Single point of failure
If a bank or centralized service is hacked, customers’ funds are immediately put at risk.
From the Lehman Brothers Crisis to DeFi Summer: How the Sector Emerged and Grew
The 2008 financial crisis (the Lehman Brothers collapse) showed the world just how vulnerable centralized finance could be. In the same year, a person or group using the name Satoshi Nakamoto published the Bitcoin (BTC) white paper, introducing the concept of peer-to-peer payments without a bank. This became the first practical step toward a financial systеm without a traditional intermediary.
Later, the idea evolved further with the launch of Ethereum (ETH) in 2015. The arrival of smart contracts created the foundation for decentralizing not only payments, but also other financial services such as lending, trading, and derivatives. This formed the prototype of what we now call DeFi.
The real explosion of interest came in the summer of 2020, during the period often referred to as DeFi Summer. At that time, Compound popularized liquidity mining, and the total value locked in DeFi (TVL) grew rapidly over a few months—from roughly $10 billion to more than $150 billion. From that point on, DeFi became one of the central topics in the crypto market.
How DeFi Works in Simple Terms
Blockchain and Smart Contracts
The Technologies Behind DeFi
The foundation of DeFi is the blockchain. A blockchain can be thought of as a database in which transaction information is recorded in blocks and stored in a distributed way across many participants around the world. Unlike a traditional systеm, where there is one owner or one central server, the data here is maintained by the network itself.
Thanks to this architecture, the blockchain offers strong resistance to data tampering and a high degree of transparency. That is why it can be used as the basis for financial services that operate without a central authority.
The second key element is smart contracts. These are what actually carry out operations in DeFi. A smart contract is a program that automatically runs when predefined conditions are met.
A simple analogy is a vending machine. If you meet the condition “insеrt money and press a button,” the machine dispenses a drink without the involvement of a cashier. In the same way, a smart contract automatically performs an action when the required conditions are satisfied—for example, paying interest, issuing a loan against collateral, or executing an asset swap.
Why Ethereum Remains the Center of DeFi
A large share of DeFi protocols is still built on Ethereum. It was the first blockchain to bring smart contracts into widespread use and to build a large developer community around them. Over the years, Ethereum has developed a powerful ecosystem of protocols, tools, and layer-2 solutions, which helps it maintain its leading position.
At the same time, DeFi has been growing rapidly on other blockchains as well, such as Solana, Arbitrum, and Polygon. The reasons are clear: on Ethereum, gas fees can be high, and transaction speed is not always ideal for users. As a result, alternative networks have been expanding quickly, and the market is becoming increasingly diverse across platforms.
Main Types of DeFi Services
DEX (Decentralized Exchanges): Uniswap, Raydium, and Others
DEX stands for Decentralized Exchange. It allows users to buy, sell, and swap cryptocurrencies directly on the blockchain, without a centralized operator. A classic example on Ethereum is Uniswap, while on Solana a well-known example is Raydium.
Unlike centralized exchanges (CEX), DEX platforms usually do not require mandatory identity verification, and the assets remain under your control at all times—in your own wallet. Another major advantage is transparency: all operations are recorded on-chain, meaning users do not depend on how an operator stores their funds.
Lending, Deposits, and Crypto Asset Management
Lending is a mechanism that allows you to lend out cryptocurrency and earn interest. Typical protocols inсlude Aave and Compound. You can also deposit an asset as collateral and borrow another cryptocurrency against it. Interest rates in these systems are calculated automatically by the protocol based on supply and demand, so there is no need for bank approval or paperwork.
Staking is another form of participation. The user locks cryptocurrency into a blockchain network, helps support its operation, and receives rewards in return. Since rewards often accumulate based on the amount staked and the length of time, staking is sometimes compared to a fixed-term bank deposit, though the comparison is not exact.
Both lending and staking are often seen as ways to “grow assets while holding them,” which is why they are usually easier for beginners to understand than more complex trading strategies.
Yield Farming, Stablecoins, and DeFi Derivatives
Yield farming is a strategy in which a user combines several DeFi protocols in order to increase overall returns. This also includes liquidity mining—providing asset pairs to DEX liquidity pools and receiving trading fees plus protocol tokens as rewards. The potential returns can be high, but the risks are also significantly greater, so this is usually considered a tool for more advanced users.
Stablecoins are crypto assets designed to maintain a price peg to fiat currencies, such as the U.S. dollar. In DeFi, DAI is widely used and is issued in a decentralized way against ETH collateral. Stablecoins are especially useful when you want to use DeFi while reducing exposure to sharp price swings.
DeFi also includes derivatives protocols, for example for trading futures and options (such as dYdX and GMX). At the same time, the DeFi insurance sector is developing, offering coverage for certain risks, including smart contract exploits (for example, Nexus Mutual). The scope of such solutions continues to expand each year.
Advantages of DeFi
1. Lower Fees and Faster Transactions
Since there are fewer intermediaries—or none at all—the cost of transactions can be significantly lower. In some cases, an international transfer that would take days in the traditional banking systеm can be confirmed on the blockchain in minutes or even seconds, depending on the network.
2. 24/7/365 Availability from Anywhere in the World
DeFi runs on programs that execute automatically, so the systеm is not limited by office hours, weekends, or bank holidays. As long as you have internet access, the services are available at any time, even without a bank account.
3. Personal Information Is Often Not Required (No KYC)
Many DeFi services do not require KYC and can be accessed by anyone who has a crypto wallet address. However, it is important to remember that the wallet address itself and its transaction history are usually publicly visible on the blockchain.
4. Anyone Can Become a Provider of Financial Services
In DeFi, ordinary users can act not only as customers, but also as liquidity providers or lenders. In other words, an individual can take part in offering financial services and earn income from it—something that is far less common in traditional finance.
Risks and Drawbacks of DeFi
What You Need to Understand Before Getting Started
Despite its huge potential, DeFi also comes with serious risks that are often absent from traditional financial services.
Main Risks
- Smart contract bugs and hacks
If there is a vulnerability in the code, malicious actors can exploit it. There have already been cases in DeFi history where losses reached tens of millions of dollars. Even well-known and established protocols cannot guarantee complete safety. - Rising network fees (gas fees)
On Ethereum, using DeFi can become expensive during periods of network congestion. Sometimes the fee for a single transaction becomes so high that it can wipe out the expected profit on smaller amounts. - Price volatility and impermanent loss
In addition to the usual risk of cryptocurrency price fluctuations, providing assets to a liquidity pool introduces a specific risk known as impermanent loss. This is one of the key concepts to understand before participating in liquidity pools. - Limited regulation and high personal responsibility
In many countries, the legal framework for DeFi is still developing. If a problem or dispute arises, legal protection may be difficult to obtain, so in most cases users act at their own risk. - Scams and rug pulls
The DeFi space regularly sees projects where developers collect funds and then abandon the project or disappear. Extra caution is needed when dealing with new, unaudited protocols.
DeFi is a field where responsibility for decisions lies with the user. That is why it is strongly recommended to start with a small amount—an amount you can afford to lose.
How to Start Using DeFi: A Step-by-Step Guide
STEP 1. Buy Ethereum on a Local (Centralized) Exchange
The first step is to purchase Ethereum (ETH) on a crypto exchange available to you. Most DeFi services operate on Ethereum or on EVM-compatible networks (such as Arbitrum or Polygon), and ETH is often needed to pay transaction fees (gas fees).
Examples of exchanges often mentioned inсlude bitFlyer, GMO Coin, Coincheck, and other platforms.
STEP 2. Set Up a MetaMask Wallet
To use DeFi, you need your own crypto wallet. One of the most common options is MetaMask, which can be installed for free as a browser extension or as a mobile app.
After installing it and creating a new wallet, you will be shown a seed phrase (usually 12–24 English words). This is the main key for restoring access. If you lose the seed phrase, recovering the wallet may be extremely difficult or impossible. That is why you should write it down and store it in a safe place.
STEP 3. Transfer ETH to MetaMask, Connect to a DEX, and Start Using DeFi
After buying ETH, transfer it from the exchange to your MetaMask wallet address. A wallet address is an alphanumeric string that usually starts with 0x. If even one character is entered incorrectly, the funds may be lost permanently. That is why the address should be copied and pasted, and then double-checked by verifying the first and last characters manually.
Once the ETH arrives in your wallet, you can visit a DEX website (for example, Uniswap), connect MetaMask, and immediately start using DeFi services: swapping tokens, participating in lending, or providing liquidity.
Once your wallet is connected, access to DeFi opens almost instantly. MetaMask also supports different networks and tokens, and the number of ways you can use it expands depending on which apps and protocols you connect to.