DeFi: Banking Without Banks

What DeFi replaces

DeFi applications use smart contracts for services such as token trading, collateralized lending, and asset management. Access conditions, administrators, and legal restrictions vary by application.

The DeFi stack

DeFi protocols can interact through shared token standards and contract interfaces. That also connects their risks: a failed dependency can affect applications built on top of it.

DEXs (Decentralized Exchanges)

Trade tokens without a centralized exchange. Uniswap is the largest. Instead of matching buyers with sellers (like the stock market), it uses liquidity pools - pots of tokens deposited by users.

When you swap ETH for USDC, you are trading against a pool, not a person. The price is set by a formula based on the ratio of tokens in the pool. The more you buy, the more the price moves.

Lending and borrowing

Deposit crypto to earn interest. Borrow crypto by posting collateral.

On Aave, supplied assets can earn variable interest, and eligible collateral can support borrowing. Liquidation depends on the market's configured thresholds and the position's health factor. Check the current parameters instead of assuming one rate or collateral ratio applies to every asset.

Yield

"Yield" is the return you earn on deposited crypto. Sources include:

• Lending interest: Earn interest by lending to borrowers
• Liquidity providing: Earn trading fees by depositing into DEX pools
• Staking: Earn rewards for validating transactions (Ethereum PoS yields ~3-4% APY)

Examples of protocol functions

Protocol	Category	What it does
Lido	Staking	Liquid staking
Aave	Lending	Collateralized borrowing and asset supply
Uniswap	DEX	Token swaps through liquidity pools
Curve	DEX	Swaps using pools designed for particular asset pairs

The risks

DeFi gives you access to financial tools without a middleman, but it also gives you full responsibility:

• Smart contract risk: Bugs in code can be exploited. Billions have been lost.
• Liquidation risk: If collateral drops in value, your position gets automatically sold.
• Impermanent loss: Liquidity providers can lose money if token prices move significantly.
• Scams: Fake protocols exist specifically to steal funds. Verify contracts before depositing.

Key takeaways

• DeFi uses smart contracts for financial operations; individual applications can impose access conditions.
• DEXs use liquidity pools and formulas instead of order books.
• Lending requires over-collateralization - deposit more than you borrow.
• DeFi gives access but also responsibility - bugs, liquidations, and scams are real risks.