PROTOCOLS7 min read

What is DeFi?

Name: Awarizon SDK
Author: Awarizon

Financial services without banks, built on smart contracts

DeFi stands for Decentralized Finance. It is an ecosystem of financial services — lending, borrowing, trading, earning yield — built on blockchain using smart contracts. No banks, no brokers, no middlemen. Just code.

Finance without a bank

When you borrow from a bank, they check your credit score, review your application, decide if you qualify, and charge you interest at a rate they set. This process takes days or weeks and excludes billions of people without formal credit history.

In DeFi, you deposit cryptocurrency as collateral into a smart contract. The contract automatically calculates what you can borrow based on programmatic rules. The transaction executes in seconds. No application. No approval. No discrimination.

The same logic applies to trading (decentralized exchanges), saving (yield protocols), and derivatives. Every financial service that banks and exchanges provide, DeFi rebuilds with code.

◆Decentralized Exchanges (DEX) — Trade crypto directly from your wallet. No account needed. Uniswap, Curve, and PancakeSwap are examples. They use "liquidity pools" instead of traditional order books.
◆Lending & Borrowing — Deposit crypto to earn interest, or borrow against collateral. Aave and Compound are the leading protocols. Rates adjust automatically based on supply and demand.
◆Stablecoins — DAI is a decentralized stablecoin created by MakerDAO. Users deposit ETH as collateral to generate DAI, maintaining the peg through smart contract incentives.
◆Yield Farming — Provide liquidity or capital to protocols in exchange for token rewards. Returns vary from a few percent to sometimes thousands of percent for new protocols (with commensurate risk).
◆Perpetuals & Derivatives — Trade leveraged positions on crypto prices. dYdX and GMX allow up to 50x leverage entirely on-chain.

A liquidity pool is a smart contract holding two (or more) tokens. Anyone can deposit tokens into the pool to become a "liquidity provider" and earn a share of trading fees.

When a trader swaps Token A for Token B, they add Token A to the pool and take Token B out. The price is determined by an Automated Market Maker (AMM) formula — typically x × y = k, where x and y are the pool balances and k is a constant. As the ratio of tokens in the pool changes, the price adjusts automatically.

⚠Impermanent Loss

If you provide liquidity and the price of the tokens diverges significantly, you may end up with less value than if you had just held the tokens. This is called "impermanent loss." It is one of the key risks for liquidity providers.

◆Smart contract bugs — Code vulnerabilities can be exploited. Billions have been lost in DeFi hacks. Always use audited protocols.
◆Rug pulls — Malicious developers drain liquidity from protocols. Research teams before depositing.
◆Liquidation risk — If your collateral value drops below the required threshold, the protocol automatically liquidates your position.
◆Oracle manipulation — DeFi protocols often rely on external price feeds (oracles). If these are manipulated, funds can be stolen.
◆Regulatory risk — DeFi operates in a legal gray area. Regulations are evolving globally.
◆No insurance — Unlike bank deposits, DeFi funds are not insured. If a protocol fails, the loss is yours.

💡Start small

If you are new to DeFi, start with small amounts on established protocols like Aave or Uniswap. Understand a protocol fully before committing significant capital.

KEY TERMS GLOSSARY

DEX

Decentralized Exchange. A trading platform running entirely on smart contracts with no central authority.

AMM

Automated Market Maker. A pricing mechanism using a mathematical formula instead of order books.

Liquidity Pool

Smart contract holding token reserves that traders swap against.

TVL

Total Value Locked. The total value of crypto deposited in a DeFi protocol, used as a measure of its size.

Yield

Returns earned by providing capital or liquidity to DeFi protocols.

Protocol

In DeFi, a protocol is a set of smart contracts that provide a specific financial service.

What is DeFi?

Finance without a bank

What is a Smart Contract?

What is Blockchain?

What is a DAO?