What Is a DeFi Vault and How Does It Work?
A DeFi vault is a smart contract that pools crypto and runs a yield strategy, usually by lending or providing liquidity through other protocols.
Vahe HakobyanEditor-in-chief
Updated Oct 6, 20263 min readFact-checked
On this page
- Smart contract bugs, strategy losses, and locked funds are main risks.
- Vault earnings are usually taxable as ordinary income when received.
- A vault is not a bank account and deposits are not insured.
The vault puts that pooled crypto to work in other DeFi protocols to earn a return.
What Is a DeFi Vault?
A vault holds crypto from many people and follows rules written in code. It lends the crypto, provides liquidity, or uses other yield strategies.
How Do You Deposit and Withdraw?
You connect a wallet and approve the deposit. The vault may give you a receipt token that represents your share. Withdrawing depends on the vault's rules, available liquidity, and network conditions.
How Is It Different from Staking?
Staking and vaults both aim to earn a return, but they work differently.
What Risks and Tax Rules Apply?
Smart contract bugs, strategy losses, and locked funds are the main risks. An audit does not guarantee safety. The IRS treats crypto as property, and vault earnings are usually taxable as ordinary income when you receive them.
Frequently asked questions
You usually give up direct control, and the contract holds the crypto. You own a claim on the pool instead of the exact coins.
There is no complete US rulebook for DeFi vaults. Securities or commodities rules may apply, and the SEC and CFTC have brought cases.
The smart contract controls the funds by its code. Developers or a governance group often set the rules and can sometimes change them.
You redeem it, and the vault sends your share back to your wallet. The token is usually burned in that process.
