Understanding Decentralised Finance (DeFi)

Introduction 

Decentralised Finance, or DeFi, is an innovative financial system that offers services such as lending, borrowing and trading without relying on third-party or centralised intermediaries. Built on blockchain technology, DeFi platforms make financial transactions accessible and transparent for anyone with an internet connection. While there are several opportunities, it’s essential to understand both the rewards and risks associated with DeFi. 

What is DeFi? 

DeFi refers to a range of financial applications and services built on blockchain networks. These platforms provide traditional financial services, like loans, savings, trading and insurance, but without central intermediaries, giving users greater control. Instead of banks, DeFi relies on smart contracts—self-executing programs that handle transactions autonomously. DeFi users interact through decentralised applications (DApps) with platforms like Aave, Compound and Uniswap offering popular services. 

Trading on DEXs 

Decentralised Exchanges (DEXs) enable users to trade cryptocurrencies directly with each other without relying on a central authority or intermediary. Unlike traditional exchanges, DEXs operate on a blockchain through smart contracts, providing a peer-to-peer trading environment. Users retain control over their assets, as trades occur directly from their wallets, offering greater security and privacy. Popular DEXs include Jupiter, Uniswap and SushiSwap.  

Lending and Borrowing 

DeFi platforms have introduced new ways to lend and borrow assets without the need for traditional banks. By depositing cryptoassets on DeFi platforms like Aave or Compound, users can earn interest as lenders, while borrowers can access funds by providing collateral. 

This process is automated and governed by smart contracts, which handle collateral management, interest rates and repayments. 

With over-collateralisation, the risk of default is mitigated, as borrowers must deposit more value than they borrow. For lenders, this provides a passive income stream, while borrowers benefit from quick, accessible liquidity without needing to sell their holdings. 

Providing Liquidity 

Providing liquidity is a key component of DeFi, enabling the functionality of DEXs and other DeFi platforms. Users deposit pairs of assets into liquidity pools, which are then used to facilitate trading, lending and borrowing. In return, liquidity providers earn fees from transactions that occur within these pools, often along with additional incentives in the form of platform tokens. 

This process allows individuals to put idle assets to work, generating yields that can exceed those found in traditional finance. However, providing liquidity also comes with risks, such as impermanent loss—when the value of deposited assets fluctuates. Platforms mitigate this through incentives and user-friendly interfaces, making liquidity provision a popular strategy for earning passive income in DeFi. 

New Innovations: Ethena, Pendle 

The DeFi landscape continues to evolve, with innovative projects like Ethena and Pendle that have grown in popularity in the past year pushing the boundaries of what’s possible.  

Ethena is developing synthetic stable assets that provide access to stable purchasing power without requiring traditional stablecoins or reserve assets, adding an entirely new layer of flexibility to DeFi.  

Pendle, on the other hand, focuses on tokenising future yield, enabling users to buy and sell projected returns from yield-generating assets. By separating the principal from future yield, Pendle creates a marketplace for yield trading, offering users more control over their returns.  

DeFi Safety Tips 

When exploring DeFi and yield farming, it’s essential to proceed with caution. Start by researching the platform and sticking to well-known options with security audits and positive reputations. Consider using smaller investments initially to reduce risk while you become familiar with the process. Understanding smart contract audits is also helpful; audited platforms don’t eliminate vulnerability risks, but they do significantly reduce them. Lastly, if you’re unsure about a protocol, avoid putting in capital until you fully understand its functionality, as lost funds in DeFi are usually unrecoverable. 

Read our Advanced Security Techniques post:

Advanced Security Techniques

To Sum It Up 

DeFi platforms offer decentralised financial services, allowing users to lend, borrow and trade without intermediaries. As DeFi grows, new ways to manage your crypto emerge, however, there are serious risks involved which can lead to loss of funds, so you need to ensure you have the best security in place and remain vigilant at all times.