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What is DeFi? How Does DeFi Work?

Mar 2, 2023
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The DeFi industry began only after the launch of the Ethereum blockchain in 2015. Ethereum’s introduction meant contracts could be agreed upon and signed on the blockchain, which inadvertently includes financial contracts could be made as well.  

Now, eight years later, with nearly 5 million participants around the globe in 2022, decentralized finance is an undeniably large part of the Web3 sphere. Although the industry suffered over last year’s market downturn, January saw the DeFi ecosystem go on the rebound, kicking off 2023 with a major surge in its TVL. As decentralized finance sees more adoption among individual users and institutions, it is bound to expand even more. Indeed, the market is expected to hit a $231.19B valuation in 2030. 

DeFi Statistics (Source: Banklesstimes)

A Breakdown of Decentralized Finance: DeFi Explained 

The term decentralized finance (DeFi) describes a financial model that utilizes blockchain technology, the same technology present in the crypto sector. Traditional systems of finance are centralized and controlled by intermediaries like banks and financial institutions. However, DeFi challenges the status quo and returns the power to individuals by offering open, and permissionless operations

Participants in decentralized finance can employ resident offerings without a middleman. That’s right, under the DeFi umbrella, individuals can carry out peer-to-peer (P2P) transactions. These are financial operations that occur directly between two participants, who also get to maintain custody of their own assets. 

Decentralized finance makes it possible for individuals to transact as long as they have internet access wherever they are across the globe. Essentially, anyone can participate in DeFi applications and access financial services without the supervision of a central authority. The DeFi ecosystem features a broad range of products and services such as lending and borrowing, trading, and asset management among others. As stated earlier, DeFi uses blockchain technology to make this possible with smart contracts at the core of most offerings.

Core Concepts in Decentralized Finance


Top of the list is decentralization. DeFi is decentralized, meaning that it is not controlled by any single entity or authority. Instead, it is built on a blockchain network that is open and transparent, with transactions recorded on a public ledger.

Smart Contracts

DeFi applications are powered by smart contracts. These are self-executing programs that automatically enforce the terms of an agreement between parties. Smart contracts are tamper-proof and operate without a middleman, making them more efficient and secure than traditional legal contracts.

Openness and Transparency

The open nature of DeFi allows anyone to participate in the network and develop new applications and services, driving innovation and competition. Transparency ensures that all transactions are recorded on a public ledger, promoting accountability and reducing the risk of fraud and corruption.

Is Decentralized Finance The Same as Cryptocurrency: What is DeFi in Crypto?

DeFi is not the same as crypto. 

A cryptocurrency such as Bitcoin is a digital asset that uses cryptography to secure transactions and control the creation of new units. Meanwhile, decentralized finance is a blanket term for a broad range of mainly blockchain-based financial applications and services. DeFi in crypto often involves the use of cryptocurrencies as a means of exchange. The DeFi ecosystem makes use of these assets alongside smart contracts to provide services that run without intermediaries. DeFi uses cryptocurrencies and smart contracts to provide services that don't need intermediaries. Therefore, while cryptocurrency is one aspect of DeFi, there are several other components.

Why DeFi Matters

Bitcoin, the pioneer cryptocurrency emerged in response to a crisis in traditional financial systems. This crisis unveiled the need for an alternative financial model that could operate independently of the traditional banking system. Thus, the Bitcoin network emerged to offer an open, transparent, and decentralized system. Decentralized finance has the same goal. However, DeFi expands on the basic premise of Bitcoin to create an entire digital alternative to traditional financial institutions across the globe.

Benefits of Decentralized Finance

  1. Accessibility: DeFi platforms are accessible to anyone with an internet connection, regardless of location or social status.
  2. User Autonomy and Anonymity: DeFi applications are non-custodial, meaning that users retain control of their assets at all times. Additionally, they can conduct financial transactions without revealing their identity.
  3. Lower Fees and High-interest Rates: DeFi enables direct transactions between participants, reducing fees and allowing negotiation of interest rates. Also, lenders on DeFi networks can earn much higher interest rates than traditional financial institutions.
  4. Security and transparency: DeFi uses smart contracts on an immutable blockchain for transparent and secure transactions. The platform preserves user privacy while offering transparency to the public.
  5.  Independence: DeFi platforms are not reliant on centralized financial institutions and are less vulnerable to exploits. 
  6. Speed: Transactions are faster due to the absence of intermediaries and borders, facilitated by the speed of blockchain technology.
  7.  Interoperability and Innovation: DeFi protocols are designed to be interoperable, which means that they can work with other protocols and systems which are constantly emerging.

What You Can Do With DeFi; Financial Products in DeFi

DeFi 2022 Market Distribution (Source: Grandviewresearch)

Some key DeFi offerings include:

Lending and borrowing platforms

With DeFi lending and borrowing services, you can lend out your crypto assets to earn interest or borrow assets using their existing crypto holdings as collateral. These platforms are typically powered by smart contracts, which automatically execute the terms of the loan agreement.


Stablecoins are cryptocurrencies that are designed to maintain a stable value, typically pegged to a fiat currency like the US dollar. They are often used as a means of exchange or as a store of value within the DeFi ecosystem

Decentralized exchanges (DEXs)

DEXes make up a significant portion of the global DeFi market. These platforms allow users to trade cryptocurrencies and other digital assets without the need for a centralized exchange or intermediary. They operate on a peer-to-peer basis, using smart contracts to facilitate trades. 

Decentralized exchange platform Uniswap

Asset management platforms

DeFi asset management platforms allow users to invest in a variety of cryptocurrency assets using a single platform. These platforms are typically powered by smart contracts, which execute investment strategies based on preDeFined rules and criteria.

Pros and Cons of Decentralized Finance


  1. Greater accessibility and inclusion
  2. Increased transparency
  3. Greater user control and flexibility


  1. Higher risk and potential for fraud
  2. Lack of regulatory oversight
  3. Limited mainstream adoption and integration with traditional finance.

DeFi Vs CeFi: A Comparison of Decentralized Finance and Centralized Finance 

What is CeFi?

Centralized Finance (CeFi) is the traditional financial system in which intermediaries such as banks and financial institutions act as gatekeepers and custodians of financial assets. In CeFi, financial transactions and assets are held and managed by third parties, who charge fees for their services.

The CeFi system is based on a hierarchical structure, where centralized authorities have full control over financial transactions and access to financial services. Although this system has been the dominant financial system for centuries, it has been criticized for being exclusionary, costly, and lacking transparency.

How Centralized Finance Meets Web3

In the context of Web3, CeFi (Centralized Finance) refers to the use of centralized platforms to facilitate financial transactions in the digital sphere. It typically requires users to undergo KYC verification, similar to traditional banking processes. 

While CeFi can provide a familiar and regulated environment for financial transactions, it relies on centralized entities to manage transactions, making it vulnerable to censorship, hacks, and other forms of disruption. Furthermore, CeFi often charges high fees for its services, limiting accessibility for many users. 

A few CeFi platforms include Binance, Coinbase,  and Gemini among others.

Differences Between CeFi and DeFi

The core difference between CeFi and DeFi is that CeFi is centralized, meaning it relies on intermediaries such as banks and exchanges to manage financial transactions, while DeFi is decentralized, meaning it operates on a peer-to-peer basis without intermediaries. 

Table showing the differences between centralized and centralized finance.








User custody

Third-party custody


Easy access for anonymous use

KYC compliance/lengthy onboarding process


More transparent 

Less transparent


Low transaction fees

Higher fees

Regulatory Oversight

Limited regulatory framework

Subject to regulation

Customer service 

No customer service 

Customer service available on major exchanges 

Is Decentralized Finance Worth Investing In?

The collapse of the centralized exchange FTX was an important test for DeFi. Despite fears that investors might abandon crypto altogether, DEX trading volumes surged during the FTX debacle in November 2022. Many traders turned to DEXs as an alternative trading option less prone to centralization failures. Increased on-chain trading activity due to volatility, the need for liquidity, and the desire to reduce exposure to a single centralized exchange may also have contributed to the surge in DEX trading volumes during the FTX collapse. Therefore, the rise of DeFi and DEXs is worth considering for investors seeking alternative trading platforms that prioritize security and liquidity.

DEX Trading Volume Surge (Source: MacroHive)


What is DeFi in blockchain?

A financial system built on blockchain technology that enables decentralized financial transactions.

What is DeFi trading?

Decentralized trading of digital assets without intermediaries.

How to get started with DeFi?

Open a digital wallet, fund it with digital assets, and access a DeFi platform. But research and understand the risks before investing.

What are the risks of using DeFi?

Smart contract vulnerabilities, liquidity issues, regulatory uncertainty, and lack of user protection.