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What is DeFi?
DeFi (decentralized finance) is a name for financial services such as trading, lending and borrowing that run as smart contracts on a public blockchain instead of through a bank or broker. Anyone with a wallet can use them, and the code, not a company, moves the funds.
What it means for you
When you use a DeFi app, your funds sit in its smart contracts. A bug or exploit in that code can drain them, and there is usually no company to reverse a mistake or refund a loss. Before depositing, check what the contract is allowed to do with your tokens and which approvals you are signing.
A common mistake: “DeFi is decentralized, so nobody controls it.”
In fact: Many DeFi platforms keep central governance that can change the rules. The BIS calls full decentralisation in DeFi 'illusory', and the ECB found governance tokens heavily concentrated in a small share of holder addresses.
How it works
DeFi apps are smart contracts that hold pooled funds and act on fixed rules: a lending contract takes deposits and lends them against collateral, an exchange contract swaps tokens against a reserve. Because they run on the same chain and speak the same interfaces, one contract can use another's tokens, so an interest-bearing token earned in one app can be traded or deposited in a second; this is called composability. The ECB notes that this reuse links protocols together, so a code exploit or a price fall in one can spread to others, and transactions on the chain cannot be reversed.
Sources: ethereum.org: Decentralized finance (DeFi), ECB Macroprudential Bulletin: Decentralised finance, BIS Quarterly Review: DeFi risks and the decentralisation illusion · checked 4 October 2026
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Educational content, not financial advice. Written by hand and checked against the source named above. Something wrong? Tell us and we reply within two business days.