DeFi Explained: The Future of Finance

Understanding Decentralized Finance (DeFi), its protocols, risks, and opportunities.

2 min read Nov 27, 2025

What is DeFi?

Decentralized Finance (DeFi) refers to financial services built on blockchain networks, primarily Ethereum. Unlike traditional finance (TradFi), DeFi operates without intermediaries like banks.

Core DeFi Primitives

1. Lending & Borrowing

Protocols like Aave and Compound enable:

Earning yield by supplying assets
Borrowing against collateral
Flash loans (uncollateralized loans within a single transaction)

// Simplified Aave interaction
interface ILendingPool {
    function deposit(
        address asset,
        uint256 amount,
        address onBehalfOf,
        uint16 referralCode
    ) external;
    
    function borrow(
        address asset,
        uint256 amount,
        uint256 interestRateMode,
        uint16 referralCode,
        address onBehalfOf
    ) external;
}

2. Decentralized Exchanges (DEXs)

Uniswap, Curve, and SushiSwap enable trustless token swaps.

Automated Market Makers (AMMs)

Instead of order books, AMMs use mathematical formulas:

def constant_product_amm(reserve_x: float, reserve_y: float, dx: float) -> float:
    """
    Uniswap V2 constant product formula: x * y = k
    
    Calculate output amount for a given input.
    """
    k = reserve_x * reserve_y
    new_reserve_x = reserve_x + dx
    new_reserve_y = k / new_reserve_x
    dy = reserve_y - new_reserve_y
    
    return dy * 0.997  # 0.3% fee

3. Stablecoins

Cryptocurrencies pegged to stable assets (usually USD):

Type	Examples	Mechanism
Fiat-backed	USDC, USDT	1:1 bank reserves
Crypto-backed	DAI	Over-collateralized
Algorithmic	FRAX	Supply adjustments

4. Yield Farming

Strategies to maximize returns by:

Providing liquidity to DEXs
Staking governance tokens
Leveraged yield farming

DeFi Risks

⚠️ Smart Contract Risk: Bugs can lead to fund loss

⚠️ Impermanent Loss: LP value < holding assets separately

⚠️ Oracle Manipulation: Price feed attacks

⚠️ Regulatory Risk: Uncertain legal landscape

Evaluating DeFi Protocols

Before investing, check:

TVL (Total Value Locked): Higher = more trust
Audit Reports: From firms like Trail of Bits, OpenZeppelin
Team: Doxxed vs anonymous
Tokenomics: Inflation, utility, governance

The Intersection with TradFi

We’re seeing convergence:

Real World Assets (RWAs): Tokenized treasuries, real estate
Institutional Adoption: BlackRock’s BUIDL fund
CBDC Integration: Central bank digital currencies

Conclusion

DeFi represents a paradigm shift in financial services. While risks exist, the innovation happening in this space is reshaping how we think about money and finance.

Documentation