GUIDE: What is DeFi?

Finance without intermediaries

DeFi stands for decentralized finance. It refers to a set of applications that replicate classic financial services—exchanging currencies, lending money, taking out a collateralized loan, purchasing insurance—but replacing the intermediary company with a smart contract, i.e., a program published on a blockchain.

The key difference lies in who holds the money. In a bank or a centralized exchange, you hand over funds and the entity custodies them. In DeFi, your coins remain in your wallet, and you authorize a contract to interact with them. No one opens an account for you, no one asks for paperwork, and no one can block your balance.

That contract is public: anyone can read its code and see all the operations it has performed. This transparency is the system's great virtue and, at the same time, its great weakness, because a coding error is visible to everyone, including attackers.

Most of the activity occurs on Ethereum and its layer-two networks, although Solana, Avalanche, and other chains have very active ecosystems of their own.

The basic building blocks: exchanges, lending, and liquid staking

The first block is decentralized exchanges. Instead of an order book, they use liquidity pools: two coins deposited by users into the same contract, with a mathematical formula setting the price based on their proportion. Those who provide liquidity earn a share of the fees from each swap.

The second block is lending protocols. You deposit one cryptocurrency as collateral and can borrow another, always at a value lower than your collateral. Interest rates adjust automatically based on supply and demand. If the value of your collateral falls below a certain threshold, the contract automatically sells it to repay the debt: this is called liquidation.

The third block is liquid staking. You lock up a cryptocurrency to help secure the network and, in return, receive a token representing that deposit, which you can then use in other applications. This way, you earn network rewards without immobilizing your capital.

Everything else is built upon these three pieces: derivatives, insurance, automated portfolio management, prediction markets, or yields on tokenized bonds. The logic is always the same: contracts that combine with each other like building blocks.

Real risks and how to start smartly

The most obvious risk is technical. A bug in a contract's code can drain it in minutes, and in DeFi, there's no deposit insurance fund or phone number to call. Serious protocols undergo external audits and have been operating for years with billions of dollars; those that are newly launched and promise huge returns are, almost always, a bad idea.

The second risk is market risk. If you use collateralized loans, a rapid price drop can liquidate your position and cause you to lose your collateral. If you provide liquidity to a pool, you may suffer what is called impermanent loss: ending up with less value than you would have had if you had simply held onto the two coins.

The third is human error. Signing an authorization without reading it, falling for a fake website, or storing your recovery phrase on your phone are the cause of most losses. In DeFi, there's no undo button: a confirmed transaction is final.

And there's a fourth point that should not be forgotten in Europe: DeFi yields are taxable. Rewards and gains from swaps must be declared in your country, even if you never convert to euros. Consult the specific rules of your tax residence.

If you want to try it, start with a small amount, on established protocols, and practice with a simple swap before touching loans or leveraged strategies.