How DeFi works
A DeFi app is usually a website connected to smart contracts. The website is the interface. The smart contracts hold the rules and assets. When you swap tokens or deposit into a pool, your wallet signs a transaction and the contract executes it.
This means DeFi can run without a traditional bank account, but it also means you must understand what you are approving.
Common DeFi activities
- Swapping: Trading one token for another through a decentralized exchange.
- Lending: Depositing assets so borrowers can use them.
- Borrowing: Taking a loan against collateral.
- Liquidity pools: Supplying assets to help markets function.
- Yield strategies: Chasing rewards, fees, or incentives.
Why yields can be misleading
A high yield is not free money. It may come from token incentives, trading fees, borrower demand, leverage, or risk that is not obvious. Yields can change quickly. A pool can lose money even while showing a high percentage.
Beginners should avoid complex DeFi until they understand wallets, approvals, token risk, and liquidation risk.
Core risks
- Smart-contract bugs can drain funds.
- Fake websites can trick users into signing bad approvals.
- Bridges have been frequent hack targets.
- Borrowed positions can be liquidated if collateral drops.
- Governance or admin keys can create centralization risk.
FAQ
Is DeFi safer than a bank?
No. DeFi removes some intermediary risks but adds smart-contract, wallet, liquidity, and user-error risks. It should not be treated as a bank replacement for beginners.
Do I need Ethereum to use DeFi?
Many DeFi apps started on Ethereum, but DeFi also exists on layer-2 networks and other blockchains. You need the right asset on the right network to pay fees.
What is a wallet approval?
An approval gives a smart contract permission to move a token from your wallet. Bad or unlimited approvals can be dangerous, so review them carefully.