What is DeFi?

Benefits and Characteristics of DeFi

Decentralized Finance (DeFi) has the long-term potential to revolutionize the traditional banking sector and related financial services—or even disrupt them entirely and render them obsolete. DeFi goes a significant step further than fintechs, which in recent years have already shaken up established banks.

Modern fintechs have introduced new products and more convenient banking experiences thanks to the increased use of software and technologies like artificial intelligence. However, they still largely rely on traditional, centralized structures. Decentralized Finance (DeFi) is fundamentally different and stands out from the traditional, centralized financial system through several distinctive characteristics:

All of these are characteristics that also apply to the pioneer of cryptocurrencies—Bitcoin. Unlike Bitcoin, which represents a free, digital monetary system and can serve as both a simple means of payment and a store of value or “digital gold,” DeFi offers many additional benefits thanks to programmable smart contracts built on blockchains like Ethereum.

With DeFi, traditional banking and financial services are shifting onto the blockchain, creating many new opportunities and solving some of the problems associated with the conventional banking sector. This starts with the simple access that DeFi projects offer.

Traditional banks not only have the power to reject customers—a practice that regularly occurs within legal boundaries—but also require you to have a bank account, which many people around the world still don’t possess. In many cases, you first have to deal with mountains of paperwork, verify your identity, and even provide insights into your personal financial situation—think credit scores. And finally, when it comes to taking out a loan, you’re often at the mercy of either an algorithm or, in some cases, still a bank employee.

All you need for DeFi is a compatible crypto wallet like MetaMask (software wallet) or Ledger Nano X (hardware wallet) and an internet connection, and you’re ready to use DeFi and its various protocols—whether from your home computer or anywhere else in the world with your smartphone.

Opening hours and long weekend delays? Those don’t exist in the crypto world. Opaque contracts and hidden clauses? Thanks to the transparent blockchain and the open-source nature of DApps (Decentralized Applications) and smart contracts, that’s virtually impossible.

One of the biggest advantages of Decentralized Finance is its decentralized structure, which is also a fundamental principle behind Bitcoin and other cryptocurrencies. Thanks to DeFi, you no longer have to entrust your capital to just a few institutions. In DeFi applications, code is law, and you always maintain control over your own money.

Shutting down DeFi protocols and apps is practically impossible—even in severe crises—because everything operates on a globally distributed blockchain, leaving no central authority with the power to intervene. The decentralized nature also means there are no banks or middlemen looking to take a cut, which keeps costs low for everyone involved.

With DeFi, you gain a certain level of independence from the small group of decision-makers who dominate the traditional, centralized banking and financial system.

Given the low-interest or even zero-interest policies in the traditional banking sector, DeFi also represents an attractive alternative for investors. While traditional investment options like savings accounts or fixed-term deposits barely earn any interest—and sometimes even face negative rates or penalty fees—DeFi projects often offer significantly higher returns through staking, lending, liquidity mining, and yield farming.

We’ll explore the different ways to earn money and generate returns with DeFi in the section further below.

How does DeFi work?

Once you start exploring DeFi and the possibilities of Decentralized Finance and decide to get involved, using it is relatively simple. All you need is a suitable wallet and a device with internet access—there are no other requirements.

Interacting with a specific DeFi project and its associated DApp (Decentralized Application) happens in various ways.

Buying or swapping tokens can be done in wallets like MetaMask with just a few clicks. Other DeFi projects, such as Aave or Compound, are easily accessible directly through your browser, where you’re guided step by step after connecting your wallet. Open the website, launch the app, connect your wallet—and you’re ready to go. The rest is handled automatically by the protocol in the background via smart contracts.

Earning Money with DeFi

There are several ways for investors to generate returns and make money with DeFi. Through staking, lending, and advanced strategies like yield farming, users can grow their capital and earn passive income.

DeFi Coins

The crypto world and blockchain technology are still in a relatively early stage of development. However, Decentralized Finance (DeFi) is a particularly new innovation that only became possible thanks to smart blockchains like Ethereum. Since 2019 and 2020, DeFi has been a hot topic in the crypto space, with particular focus on the following projects and protocols.

Popular DeFi-Coins

Coin/Token	Market Cap	TVL	Market Cap/TVL Ratio	Sector
Ethereum  (ETH)	$505.46B	$88.64B	5.7	Smart Contracts
Chainlink  (LINK)	$14.61B	–	–	Oracles
Uniswap  (UNI)	$4.59B	$2.84B	1.62	DEX
Aave  (AAVE)	$4.18B	$43.51B	0.096	Lending
Compound  (COMP)	$399.94M	$2.83B	0.14	Lending

Aave

Aave is one of the best-known DeFi solutions. The name “Aave,” which is Finnish for “ghost,” represents a lending protocol built on the Ethereum network that emerged from an ICO in 2017—originally under the name ETHLend. With Aave, users can either take out loans or earn money by lending their holdings—all without intermediaries like banks, in true DeFi fashion.

Liquidity for lending comes from investors who deposit their cryptocurrencies into a pool and, in return, earn interest. On the other side, users can borrow funds from this pool. Today, Aave supports more than 20 different cryptocurrencies that users can lend or borrow, including stablecoins like USDC, TUSD, BUSD, and USDT. Thanks to these stablecoins pegged to the U.S. dollar, it’s even possible—at least indirectly—to invest in traditional currencies like the U.S. dollar without taking on additional currency risk.

One unique feature of the Aave protocol is the so-called flash loans. These are instant loans that can be taken out without collateral. However, flash loans are only granted under the condition that they’re repaid within the same Ethereum block. If the repayment doesn’t happen in time, the entire transaction becomes invalid and is rolled back. As a result, there’s no risk of losing capital. Flash loans are designed for advanced users and entities like decentralized exchanges that need short-term capital for arbitrage opportunities or liquidity for swapping cryptocurrencies.

Maker

Maker is the governance token of MakerDAO, one of the first successful DeFi projects on the programmable Ethereum platform. At the core of MakerDAO lies the Maker Protocol, which enables decentralized lending. Users who need capital can deposit various cryptocurrencies as collateral and receive their loan in DAI, a stablecoin pegged to the value of the U.S. dollar. Borrowers can repay the borrowed capital at any time and, in return, regain full control over their deposited collateral. Once repaid, the DAI tokens are automatically burned.

The Maker (MKR) governance token serves two key purposes: holders can help shape the Maker platform and use their voting rights to adjust parameters—for example, the ratio of DAI issued to collateral deposited. For this role, MKR holders are rewarded with fees.

However, they also carry risk because MKR holders act as the buyers of last resort for issued DAI loans. If the collateral backing the loans becomes insufficient—such as after a flash crash—new MKR tokens are minted and sold on the open market to replenish the collateral pool. This process dilutes the value of existing MKR tokens.

Compound

Compound is one of the pioneers in the DeFi sector and runs on the Ethereum blockchain. Compound is another lending protocol that allows users to lend and borrow money. Storage and management of assets are handled automatically by smart contracts—everything operates in a decentralized way, without banks or other intermediaries.

The protocol is open to anyone who has a wallet like MetaMask and an internet connection. Users can deposit various cryptocurrencies and earn interest. On the other side, users also have the option to take out loans and borrow capital. Interest rates are variable and are automatically adjusted by the Compound protocol based on supply and demand.

Compound supports lending and borrowing for various cryptocurrencies, including well-known examples like:

With its native governance token COMP and the associated voting rights, users can actively participate in shaping the future development of Compound and make changes to the protocol through majority decisions.

Uniswap

Uniswap is an AMM, or Automated Market Maker. It’s an open-source protocol that operates on the Ethereum blockchain and is based on smart contracts. Uniswap functions as a type of decentralized exchange (DEX). Users can easily and quickly swap Ether (ETH) for ERC-20 tokens or exchange ERC-20 tokens with each other—completely without intermediaries.

There are no order books like those found on traditional exchanges. Instead, everything happens automatically through the Uniswap protocol, which matches buyers and sellers.

Trading on Uniswap is extremely simple. After connecting a compatible wallet like MetaMask, just a few clicks on the straightforward and user-friendly interface are all it takes to swap tokens—with no waiting time.

With the governance token UNI, users have a say in how Uniswap develops and can actively shape its future.

Chainlink

Chainlink (LINK) aims to connect smart contracts on the blockchain with the “real world.” Smart contracts might rely on specific conditions, such as a soccer match result. But how does that football result get into the blockchain reliably? The solution lies in so-called oracles—impartial services that gather off-chain information, process it, and deliver it to the blockchain.

Chainlink’s goal is to build a decentralized, and thus impartial, oracle network over time. Chainlink consists of both an on-chain and an off-chain component, which work together to create a bridge between the blockchain and the real world.

The potential applications are incredibly diverse. Chainlink can “translate” everyday information like football scores for use on the blockchain but can also deliver data such as weather information, stock prices, or pricing data—laying the foundation for many future DApps.

For internal payments of on-chain transactions, Chainlink uses its native ERC-20 token, called LINK, which, like other tokens, can be traded freely.

The Future of Decentralized Finance (DeFi)

Decentralized Finance has sparked significant hype in the crypto world—and not without reason. DeFi is already a strong alternative to traditional financial instruments and offers attractive return opportunities for investors. Its decentralized structure provides independence from banks, central banks, and other institutions in the traditional financial system. Access to various DeFi projects is simple and globally available—all you need is a compatible wallet.

Decentralized Finance definitely has the potential to shake up the established financial system, even though the true “killer app” might still be missing—especially when it comes to connecting DeFi seamlessly with traditional currencies like the euro or the U.S. dollar.

That kind of use case could still emerge, as the DeFi world is young and in the early stages of development. Decentralized Finance is here to stay, and it’s worth exploring—for crypto enthusiasts, tech innovators, and potential investors alike who are seeking new opportunities for returns.