What is
DeFi?

DeFi stands for decentralised finance. It is a collection of applications — mostly built on Ethereum — that replicate traditional financial services using smart contracts instead of institutions.

Want to lend money and earn interest? There is a DeFi protocol for that. Want to borrow against your crypto without selling it? There is a protocol for that too. Want to swap one token for another without creating an account anywhere? That is what a decentralised exchange does.

Everything operates through code. There is no customer service desk. No complaints procedure. No Financial Ombudsman Service. The smart contract is the counterparty. If it works as written, you benefit. If it has a bug, you bear the loss.

Lending and borrowing. Protocols like Aave and Compound allow you to deposit crypto and earn interest from borrowers. Borrowers post collateral (usually worth more than the loan) and pay interest. Rates are set by supply and demand, not a committee.

Swapping tokens. Decentralised exchanges (DEXs) like Uniswap let you swap one token for another directly from your wallet. No account creation. No identity verification. Liquidity comes from pools funded by other users who earn fees in return.

Providing liquidity.You can deposit pairs of tokens into a liquidity pool and earn a share of trading fees. This is called being a “liquidity provider.” The yields can be attractive. The risks — particularly impermanent loss — are real and poorly understood by most participants.

Yield farming.Moving funds between protocols to chase the highest returns. This was the dominant activity in the 2020 “DeFi summer.” It is high-risk, technically demanding, and often rewarded in tokens whose value declines rapidly.

Smart contract bugs.If a protocol's code has a vulnerability, attackers can drain funds. This has happened repeatedly. In 2022 alone, over $3 billion was stolen from DeFi protocols. Audits reduce risk but do not eliminate it.

Impermanent loss. When you provide liquidity to a pool and the price of one token moves significantly relative to the other, you end up with less value than if you had simply held the tokens. The maths is counterintuitive and catches many beginners off guard.

Rug pulls. New protocols launched by anonymous teams can disappear with deposited funds. There is no recourse. Due diligence in DeFi means reading code or trusting those who have.

No consumer protection. DeFi is not regulated by the FCA. The Financial Services Compensation Scheme does not cover losses. You are entirely on your own.