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DeFi & Web3Beginner

What is decentralized finance and how does it work?

Decentralized finance is blockchain software that replaces banks with smart contracts. You connect a wallet and usually keep control of your own keys.

Vahe HakobyanVahe HakobyanEditor-in-chief Updated Oct 6, 20263 min readFact-checked
A dark navy background with glass cubes joined by glowing green lines on the right.
Illustration: World-Crypt
On this page
What is DeFi in plain words?How does DeFi work without banks?What can you do with DeFi?What are the main DeFi risks?How is DeFi different from regular crypto apps?FAQ
Key takeaways
  • Smart contracts hold funds and run trades automatically.
  • You connect a wallet and keep your own keys.
  • US bank deposits have FDIC insurance; DeFi funds usually do not.

Short answer

DeFi is blockchain based financial software that replaces banks and brokers with smart contracts. It supports lending, borrowing, trading, and fees. You use it by connecting a crypto wallet to an app.

Many apps use the label, and not every one is fully decentralized. Some have controlling teams or admin keys. Yields are not guaranteed.

What is DeFi in plain words?

DeFi at a glance

Middlemen
Removes much of the need
Used for
Borrow or lend money
Main risk
Coding errors and hacks

DeFi is blockchain based financial software that replaces banks and brokers with code. Smart contracts on public blockchains carry out agreements automatically.

How does DeFi work without banks?

You use DeFi by connecting a crypto wallet to an app. The wallet holds your keys and approves each transaction, while the app's smart contracts hold funds and execute transactions.

The app can see your public address but cannot move funds without your signature. Each loan or trade is a transaction you approve.

What can you do with DeFi?

DeFi supports lending, borrowing, trading, and earning fees. You can lend crypto to a pool, borrow against collateral, or swap tokens through pools.

  • Lend crypto to a pool and earn interest.
  • Borrow against crypto by posting collateral.
  • Trade one token for another on a decentralized exchange.

What are the main DeFi risks?

US bank deposits have FDIC insurance. DeFi funds generally do not. Hacks, coding errors, and failed protocols can wipe out funds. Yields are not guaranteed. US rules can block access or treat tokens as securities.

US bank deposits compared with DeFi funds
US bank deposits DeFi funds
FDIC insurance within limits Generally no FDIC insurance
Wrong address sends can be reversed Wrong address sends are usually irreversible

How is DeFi different from regular crypto apps?

Regular crypto apps often work like centralized exchanges. They hold your keys or control your account. DeFi apps usually let you keep your keys.

Centralized crypto app compared with a DeFi app
Centralized crypto app DeFi app
Exchange controls your keys You control your own keys
Company can freeze your account Access depends on the app and rules

Frequently asked questions

DeFi is not banned as a broad category, but US regulators apply securities and money transmission rules to parts of it.

The IRS treats cryptocurrency as property, so trades, loan interest, and rewards are usually taxable.

Blockchain transfers are usually irreversible, so a wrong address can mean the funds are lost.

Was this guide helpful?
Written byVahe HakobyanVahe Hakobyan is the editor-in-chief of World-Crypt. He covers bitcoin, markets and regulation, and leads the newsroom that fact-checks every story before it goes live.

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