What is DeFi?

DeFi is short for decentralised finance: financial services run by smart contracts on a public blockchain, not by a company. You use them from your own wallet. This lesson explains what that means and what it does not.

The same services, a different operator

A bank or an exchange is a company that holds your money and keeps the records. In DeFi, a smart contract does the job. Lesson 7 described a smart contract as a program stored on a blockchain that runs exactly as written.

Most DeFi runs on Ethereum and networks built on it. The main services are familiar:

• Swapping one token for another on a decentralised exchange
• Lending tokens to earn interest
• Borrowing against tokens you already hold
• Stablecoins, covered in Lesson 10, which most of the rest depends on

What is different

• You keep your keys. The contract only moves your tokens when you sign a transaction. There is no account to open and no identity check.
• It never closes. Markets run every hour of every day.
• The code and the records are public. Anyone can inspect a contract and every transaction it has handled.
• Services plug into each other. A token you receive from one service can be used as a deposit in another. That is powerful, and it means a failure in one place can spread to others.

What you give up

There is no helpdesk, no password reset and no deposit insurance. A transaction you sign is final. If the contract has a flaw, or you approve the wrong thing, nobody is obliged to make you whole.

Every action also costs a network fee, and a failed transaction still costs one. Lesson 32 covers gas.

How decentralised is it?

Less than the name suggests. The Bank for International Settlements studied DeFi in 2021 and concluded that "full decentralisation in DeFi is illusory".

Three things are worth checking in any service:

• Who can change the code? Many contracts can be upgraded by a small group holding special keys.
• Who votes? Holders of a governance token decide on changes. Those tokens are often concentrated among founders and early investors.
• Who runs the website? The contract may be public, but the site you use to reach it is usually run by a company. It can be taken down, changed or copied by a scammer.

The same study found that DeFi at the time was used mostly for speculation and arbitrage, not for everyday finance.

Before you try it

• Finish Level 2 first. DeFi only works from a wallet you control.
• Start with an amount you could lose without it mattering.
• Read every wallet prompt before you sign. Lesson 37 explains approvals.
• Prefer services that have run for years and published independent audits. An audit lowers the risk. It does not remove it.

The next four lessons cover swapping, lending, where the returns come from and what goes wrong.