Understanding DeFi: the opportunities, risks and applications of decentralized finance

In everyday life, almost everything money-related is done through banks: payments, saving, investing or taking out loans. The traditional financial system is ubiquitous and is gaining new impetus through blockchain. One of these developments is called DeFi.

DeFi describes financial services without banks or central platforms. Processes are automated, transparent and available at all times. Anyone looking into cryptocurrencies will encounter DeFi sooner or later. But what’s it all about, what opportunities does it offer, and what do you need to bear in mind?

What is DeFi?

At the heart of DeFi are applications based on blockchain . They do not require any central providers and use what are known as smart contracts. These are programmes that automatically execute what is defined in the code. For example, a loan can be granted or a payment triggered without a bank granting the loan or verifying the payment.
Several smart contracts together form decentralized applications, known as dApps. They digitally map traditional financial services such as loans, trading and interest operations. All transactions are saved directly on the blockchain and are visible to everyone.

While banks broker and manage assets and provide specialized services such as consulting, DeFi works completely digitally and largely without a central authority.
 

What you need to get started

To get started with DeFi, you need a few basic things. Programming knowledge is not absolutely necessary. It is more important to understand how wallets, cryptocurrencies, applications and smart contracts interact. Anyone who also knows how smart contracts work and what to bear in mind when using them can make a well-informed start in the world of decentralized finance.

The wallet as a starting point in DeFi

Absolutely key is a “wallet”. Specifically, this is a digital wallet that stores cryptocurrencies and connects users with decentralized applications. There are different types of wallets. Hot wallets such as MetaMask run in the browser or as an app.

A hardware wallet, for example, may be suitable for larger amounts or longer storage periods. This is a special hardware device with additional security. Find out more in the article “Crypto custody: everything you need to know”.

Cryptocurrencies as a digital payment method

In addition to a wallet, you need an initial cryptocurrency to carry out transactions or use applications. This is usually Ether (ETH), the native token of the Ethereum blockchain. Stablecoins such as USDT and USDC are also widespread, as their value is pegged to the US dollar and therefore fluctuates less.

Use decentralized applications (dApps)

You can connect to the world of DeFi via decentralized applications, or dApps for short. They run directly on the blockchain and replace traditional financial platforms. Access is not obtained via username and password, but via the user’s own wallet. Once this has been set up, dApps can be used in the browser itself.

DeFi use cases

DeFi offers a wide range of options for actively using cryptocurrencies − from lending to automated trading strategies. The following examples show how DeFi works in practice.

Lending cryptocurrencies

With lending, investors lend their cryptocurrencies to others and receive interest in return. This allows digital assets to be used passively. The conditions and processes are set out in the programme code: loans, repayments and interest calculations run automatically. The interest rate adjusts dynamically depending on how much capital is in the pool and how much demand there is for loans.

One example is Aave, where users provide cryptocurrencies such as Ether, which other users can borrow. Interest rates are constantly changing with supply and demand.

Borrowing

If you need liquidity at short notice, you can deposit your own cryptocurrencies as collateral and borrow other tokens in return. No creditworthiness check is required. The amount deposited must exceed the borrowed value. This principle is called over-collateralization and reduces the risk of payment defaults.

Platforms such as Aave or Compound process these loans automatically and continuously, from deposit to repayment.

Exchange cryptocurrencies directly

With decentralized trading, cryptocurrencies are exchanged directly between users, without a central exchange, registration or any intermediaries.

While traditional stock exchanges work with order books where offers to buy and sell are combined, DeFi uses a different principle: liquidity pools. Users place their cryptos in shared pools from which other users can exchange tokens directly. Smart contracts automatically govern the trading price.

One of the best-known platforms is Uniswap. Here, tokens can be traded around the clock, transparently, automatically and without central control.

Staking and network participation

Staking involves locking your own cryptocurrencies to the blockchain network to confirm transactions and guarantee the stability of the system. In return, participants receive regular returns in the form of new tokens.

Staking is similar to earning interest, but it works differently: the rewards do not come from lending, but from active participation in network operations. The more tokens are locked to the blockchain, the more secure it will be.

Platforms such as Lido make it easier to get started with staking. This means that even users with smaller amounts can participate without having to worry about the technical set-up in detail.

Combine yield strategies (yield farming)

Yield farming is about distributing capital across various DeFi applications to maximize potential returns. This involves moving assets between different applications using automated protocols to where the best potential returns are.

This strategy is aimed at experienced users who understand the mechanisms and risks of decentralized financial markets. One example is Yearn Finance: the platform constantly analyses various DeFi protocols and invests capital dynamically where the highest potential returns lie.

Differences between DeFi and traditional finance

DeFi maps many traditional financial functions digitally, but works fundamentally differently. The following overview shows how the main features of decentralized and traditional financial systems differ:

DeFi market size

The size of the DeFi market can be seen in the “total value locked” (TVL). It shows how much capital is tied up in smart contracts, i.e. the crypto assets that investors have stored in DeFi protocols. The TVL is an important indicator of activity, trust and growth.

After a strong upturn, the TVL reached around 180 billion US dollars in 2021. It then fell as a result of the general market decline, before stabilizing again from 2023. At the beginning of October 2025, the TVL stood at around 160 billion US dollars. This shows that, after a phase of consolidation, DeFi is regaining strength.

The volumes remain small compared to the global financial system, but the growth illustrates the momentum. More and more capital is flowing into protocols that handle loans, trading, and yield strategies entirely digitally.

Keep an eye on the risks

DeFi brings new opportunities, but also new challenges. Decentralized investors bear more responsibility and should be aware of the risks.

• Technical errors: smart contracts execute transactions automatically. If they are incorrectly programmed, this can lead to losses, often without the possibility of correction. Unlike traditional financial systems, there is no entity that can intervene or reverse a transaction.
• Hacks and security loopholes: even if many DeFi protocols are well tested, they remain a target for attacks. Hackers can exploit vulnerabilities and steal funds, and it is often not clear whether these can be replaced and how.
• Market fluctuations: cryptocurrencies are known for their high volatility. Significant price losses can suddenly result in collateral no longer being sufficient, which can automatically lead to the liquidation of a loan, for example. Find out more in the article “Understanding volatility in cryptocurrencies”.
• No depositor protection: while bank deposits in Switzerland are protected by law for up to 100,000 francs per customer, there is no comparable legal protection in the DeFi sector at all.
• Full personal responsibility: users have control over their own assets. If you lose your wallet access data (seed phrase), you also lose the invested assets.
   

DeFi: Where is it headed?

DeFi is more than just a trend. New protocols, applications and business models are emerging worldwide. At the same time, there is growing interest in clear rules to reduce risks such as hacks, fraud or unclear liability.

To meet the growing interest and counteract the risks of decentralized applications, traditional financial service providers are also integrating selected DeFi elements into their existing services. This allows innovative features such as staking to be used in a regulated, familiar environment. Investors benefit from greater security without sacrificing the opportunities offered by new technologies.