What Is DeFi? A Plain-English Definition

Decentralised finance (DeFi) has evolved from a niche blockchain experiment to a multi-hundred-billion-dollar ecosystem that is fundamentally reshaping how people lend, borrow, trade, and earn yield — without a single bank involved. This guide explains everything you need to know, from first principles to the most advanced protocols, vetted by our financial technology analysts.

Last updated: | Reviewed by the FintechWizard Editorial Team

What Is DeFi? A Plain-English Definition

Decentralised finance (DeFi) is a category of financial applications built on public blockchains — primarily Ethereum — that replicate and improve upon traditional financial services without requiring a central authority like a bank, broker, or exchange.

Instead of trusting a company to hold your money and execute transactions, DeFi applications use smart contracts: self-executing programs stored on the blockchain whose rules are open-source, transparent, and cannot be altered by any single party.

Think of DeFi as a global, open financial system that is:

• Permissionless — anyone with an internet connection and a crypto wallet can access it
• Trustless — you don’t need to trust a counterparty; the code enforces the rules
• Transparent — every transaction is publicly verifiable on the blockchain
• Non-custodial — you retain full control of your assets at all times
• Composable — protocols can be stacked together like financial Lego bricks

As of 2025, the DeFi ecosystem has surpassed $200 billion in total value locked (TVL) across lending, trading, derivatives, yield, and insurance protocols.

How DeFi Works: Smart Contracts Explained

The backbone of DeFi is the smart contract. First introduced by computer scientist Nick Szabo in 1994 and made practical by Ethereum in 2015, a smart contract is a program that automatically executes predefined actions when specified conditions are met — all without human intermediaries.

A Practical Example: DeFi Lending

In traditional banking, you’d approach a bank for a loan, submit documents, wait for approval, and pay interest to the bank’s shareholders. In DeFi lending on a platform like Aave:

1. Lenders deposit cryptocurrency (e.g., USDC stablecoins) into a smart contract pool
2. The smart contract automatically earns them a variable interest rate based on supply and demand
3. Borrowers access these funds by depositing over-collateral (e.g., $150 ETH to borrow $100 USDC)
4. If collateral falls below the liquidation threshold, the smart contract automatically liquidates it
5. No credit check, no approval process, no bank — just code

The process is trustless because the smart contract code — not a company promise — enforces every rule. You can verify the exact code running the protocol at any time.

The Role of Blockchain

DeFi requires a blockchain to function because it needs an immutable, decentralised ledger to record state changes (who owns what). Ethereum remains dominant for DeFi due to its developer ecosystem, security, and composability. Other DeFi-active chains include Solana, Avalanche, Arbitrum, and Base.

DeFi vs. Traditional Finance (TradFi)

The 8 Leading DeFi Protocols in 2025

The DeFi ecosystem is vast, but these eight protocols represent the most established, highest-liquidity, and most-audited applications. We rank them by category and explain their utility:

1. Uniswap — Decentralised Exchange (DEX)

Uniswap pioneered the Automated Market Maker (AMM) model, enabling permissionless token swaps using liquidity pools rather than order books. With over $5 billion in weekly trading volume, it is the most-used DEX in the world. Uniswap v4 introduces “hooks” — customisable smart contract logic for liquidity providers. Learn more about DeFi exchanges →

2. Aave — Decentralised Lending Protocol

Aave allows users to earn interest on deposits and borrow against collateral. Its flash loan feature — uncollateralised loans that must be borrowed and repaid within a single transaction — pioneered a new primitive in crypto finance. Aave manages over $12 billion in assets across 12 blockchain networks.

3. MakerDAO / Sky — CDP Stablecoin

MakerDAO created DAI, the first decentralised stablecoin, backed by crypto collateral managed via Collateralised Debt Positions (CDPs). In 2024, MakerDAO rebranded to Sky and launched the USDS stablecoin as part of its “Endgame” governance restructuring.

4. Compound — Algorithmic Money Markets

Compound popularised algorithmic interest rate markets for crypto assets. It also pioneered the concept of governance tokens (COMP), where protocol users earn voting rights proportional to their activity — a model now adopted across DeFi.

5. Curve Finance — Stablecoin DEX

Curve specialises in low-slippage swaps between similarly-priced assets (stablecoins, liquid staking tokens). Its “Curve Wars” — protocols competing to direct CRV emissions toward their liquidity pools — became a defining chapter in DeFi game theory and tokenomics.

6. Lido Finance — Liquid Staking

Lido enables Ethereum staking without the 32 ETH minimum. Users deposit ETH and receive stETH — a liquid token representing staked ETH plus accruing rewards. With over 9 million ETH staked (~$28 billion), Lido is the largest liquid staking protocol and a critical piece of Ethereum’s validator ecosystem.

7. GMX — Decentralised Perpetuals Exchange

GMX enables leveraged perpetual futures trading directly from a self-custody wallet. Traders pay fees to GLP liquidity providers, who earn yield in return. GMX pioneered the “real yield” narrative in DeFi, paying out actual protocol revenue rather than inflationary token emissions.

8. EigenLayer — Restaking Infrastructure

EigenLayer introduced “restaking” — allowing staked ETH to simultaneously secure multiple protocols. This innovation lets validators earn additional yield while providing cryptoeconomic security to new applications, creating an entirely new layer in the Ethereum security stack.

How to Get Started With DeFi: A Step-by-Step Guide

Prerequisites: You will need a self-custody wallet, some cryptocurrency, and an understanding of gas fees and smart contract risks before interacting with any DeFi protocol.

1. Set up a self-custody wallet — MetaMask (browser), Rabby (browser), or Coinbase Wallet are the most widely supported. Write down your seed phrase and store it offline, in multiple secure locations.
2. Acquire cryptocurrency — Purchase ETH or a stablecoin like USDC on a regulated exchange (Coinbase, Kraken, etc.) and transfer it to your self-custody wallet.
3. Bridge to your chosen network — If using a Layer 2 like Arbitrum or Base, bridge your assets using the official bridge. This reduces transaction fees by 95%+ compared to Ethereum mainnet.
4. Start with simple protocols first — Begin with established, heavily-audited protocols. Uniswap (swapping), Aave (lending/borrowing), and Lido (ETH staking) are the safest starting points for new DeFi users.
5. Always verify contract addresses — Access protocols via official websites only. Bookmark them. Never click DeFi links in Discord, Telegram, or emails — phishing is the #1 attack vector in DeFi.
6. Start with small amounts — Even battle-tested protocols can have unexpected vulnerabilities. Never invest more than you can afford to lose in any DeFi protocol.

DeFi Risks: What Every User Must Understand

DeFi offers genuine financial innovation, but it carries unique risks that do not exist in traditional finance. Understanding these risks is essential before committing capital.

Smart Contract Risk

The code enforcing DeFi rules can contain bugs. In 2022–2024, over $3 billion was lost to smart contract exploits. Even audited protocols have been hacked. Key indicator: look for multiple audits from firms like Trail of Bits, OpenZeppelin, Certora, and Chainalysis.

Liquidation Risk

DeFi loans are over-collateralised. If your collateral value drops below the liquidation threshold (typically 80–85% LTV), the protocol will automatically sell your collateral. Volatile markets can trigger cascading liquidations rapidly.

Oracle Risk

DeFi protocols use price oracles (typically Chainlink or TWAP calculations) to determine asset values. Manipulated or stale oracle prices can cause incorrect liquidations or enable exploits. Flash loan attacks in 2020 exposed this vulnerability.

Regulatory Risk

DeFi regulation is rapidly evolving. The EU’s MiCA regulation, SEC enforcement actions against DeFi protocols, and FATF guidance on virtual assets create legal uncertainty. Protocols without front-end restrictions could face enforcement action in certain jurisdictions.

Impermanent Loss

Liquidity providers in AMM pools can experience impermanent loss — a reduction in value compared to simply holding the assets — when token prices diverge significantly. Understanding IL is critical before providing liquidity to any pool.

DeFi Regulation: The Global Landscape in 2025

Regulatory clarity for DeFi has accelerated globally. Here is where major jurisdictions stand:

• United States: The SEC has pursued enforcement against certain DeFi protocols as unregistered securities exchanges. The FIT21 Act (2024) established a framework distinguishing digital commodities from securities, with the CFTC gaining jurisdiction over most DeFi tokens.
• European Union: MiCA (Markets in Crypto-Assets Regulation), fully applicable from December 2024, covers centralised crypto services. Fully decentralised DeFi protocols are currently excluded, though a review clause may bring them in scope by 2026.
• United Kingdom: The FCA has been developing a crypto asset regulatory regime. DeFi is addressed in its 2023 discussion paper, with consultation ongoing on how to treat DeFi within the Financial Services and Markets Act.
• Singapore: MAS has adopted a nuanced approach, licensing DeFi activities that touch fiat currencies while allowing fully on-chain activities more flexibility.

Frequently Asked Questions About DeFi