DeFi (decentralized finance) means financial services such as payments, lending, borrowing and trading that run as smart contracts on public blockchains, with no bank or broker in the middle. Ledger Academy defines it as "blockchain-based protocols, products, and platforms that serve as alternatives to traditional financial infrastructure." Because there is no intermediary, there is usually nobody to reverse an error either. In Ledger's words, "if you make a mistake, there's nobody to help you get your crypto back." The protection a bank or broker would give you is replaced by your own key security, your own checks and the code itself.
How DeFi works
Smart contracts in place of an institution
A DeFi service is a program deployed on a blockchain. It holds funds and follows its rules automatically, for example "lend at this rate" or "sell collateral below this ratio." Ethereum.org calls DeFi "a collective term for financial products and services that are accessible to anyone who can use Ethereum." It lists the differences from traditional finance:
- Open access. "DeFi is open to anyone." You do not apply for an account.
- No gatekeeper. "There are no centralized authorities who can block payments or deny you access."
- Always on. "The markets are always open."
- Transparent. "Anyone can look at a product's data and inspect how the system works."
Ledger Academy adds that users "are not required to identify themselves or provide any documentation to access DeFi services."
Where it runs
Ledger Academy wrote that "the majority of DeFi applications (at the time of writing) exist on the Ethereum blockchain." It names Solana and Cardano as other networks that host DeFi. That page was last updated on May 25, 2023, so a newer figure helps. On Oct. 25, 2026, DefiLlama's public chains data showed about $89.1 billion in total value locked (TVL) across all chains it tracks. Ethereum held about $48.8 billion of that, roughly 55%, and Solana about $5.8 billion. TVL moves with token prices and depends on what each tracker counts, so treat these numbers as a snapshot.
What you need to start
- A self-custody wallet. Ethereum.org says "wallet providers don't have custody of your funds". The wallet gives you access to assets that stay on the blockchain. Your recovery (seed) phrase "is the only way you'll be able to recover your wallet."
- The network's native token for fees. On Ethereum, "gas fees have to be paid in Ethereum's native currency, ether (ETH)." Ethereum.org also notes that "the fee is paid regardless of whether a transaction succeeds or fails". A failed transaction still costs you money.
For background, see our explainers on how a crypto transaction is signed, broadcast and confirmed and what gas is on Ethereum.
The main building blocks
Stablecoins
Price swings make crypto awkward for loans and payments. Stablecoins address this. Ethereum.org says coins like Dai or USDC "have a value that stays within a few cents of a dollar."
Lending and borrowing
Ethereum.org says "decentralized lending works without either party having to identify themselves." The borrower "must put up collateral that the lender will automatically receive if their loan is not repaid."
Compound's documentation shows how this works in practice. Each collateral asset has a borrow collateral factor, which sets how much you can borrow at the start. It also has a higher liquidation collateral factor. "When an account's borrow balance exceeds the limits set by liquidation collateral factors, it is eligible for liquidation." Any address can then trigger liquidation, and the protocol takes over the debt and the collateral. Buyers can later purchase that collateral "at a discount from the Price Feed's price." For the borrower, a fall in the collateral's price can mean losing it automatically, with no margin call from a person and no grace period beyond what the code allows.
Flash loans
Ethereum.org calls flash loans "a more experimental form of decentralized lending." The loan "is taken out and paid back within the same transaction," and if it cannot be repaid, "the transaction reverts as if nothing ever happened."
Something went wrong in DeFi: can it be undone?
Pick what happened to see what the article says usually follows and who, if anyone, can fix it.
What happened?
- I sent funds to the wrong address → Normally permanent
- I signed a malicious contract → Normally permanent
- I lost my seed phrase → The wallet may be gone for good
- My transaction failed → The fee is still spent
- The price of my loan collateral fell → next question
- The protocol I used had a bug or exploit → Code risk falls on you
Has your borrow balance gone past the limit set by the protocol's liquidation collateral factor?
- Yes, it is past that limit → Eligible for liquidation
- No, or I don't know yet → Find the threshold before the code does
Transactions can't be reversed and there is no customer support in crypto. No bank or broker sits in the middle to call back a transfer or undo a signature.
The recovery (seed) phrase is the only way to recover a self-custody wallet. Wallet providers don't hold your funds, so they can't restore access.
Gas is charged whether a transaction succeeds or fails, and on Ethereum it is paid in ETH. Read what a transaction does before you sign it.
Any address can trigger liquidation. The protocol takes over the debt and the collateral, and buyers can later purchase that collateral at a discount. Nobody gives a margin call, and there is no grace period beyond what the code allows.
The liquidation collateral factor is higher than the borrow collateral factor. Find it in the protocol's own documentation and work out how far your collateral's price can fall before you reach it.
DeFi software can suffer from bugs and exploits, and DeFi apps are not subject to the same legal scrutiny as traditional consumer services. Usually there is nobody to make you whole.
This follows the general rules described in the article only. It cannot check your transaction, wallet or loan, and the rules and mechanics differ by protocol and country.
Who fixes a mistake
Usually nobody. Three things a bank customer takes for granted are missing:
- No reversal. Ethereum.org says "transactions can't be reversed and wallets can't be easily recovered," and "there's no customer support in crypto." A transfer to the wrong address, a signature on a malicious contract or a lost seed phrase is normally permanent.
- Code risk falls on you. Ethereum.org says "Ethereum products, like any software, can suffer from bugs and exploits." It also says users currently need "to trust the more technical members of the Ethereum community who can read code."
- Less legal oversight. Ledger Academy says "DeFi apps are not subject to the same legal scrutiny as traditional consumer services." It also says self-custody brings "the responsibility of securing your private keys."
See our guide to what happens if you lose your keys.
How regulators see DeFi
"Decentralized" is not a legal exemption by default.
- United States. On April 6, 2023, the U.S. Treasury published what it called "the first illicit finance risk assessment conducted on decentralized finance (DeFi) in the world." It found that "the primary vulnerability that illicit actors exploit stems from non-compliance." It also said covered DeFi services carry anti-money-laundering obligations "regardless of whether the services claim that they currently are or plan to be decentralized."
- Global standard setters. On Dec. 19, 2023, IOSCO, the international body of securities regulators, published its Final Report with Policy Recommendations for Decentralized Finance. The report has nine recommendations in six areas, including identifying responsible persons, managing key risks, disclosure and cross-border cooperation.
- European Union. Recital 22 of the Markets in Crypto-Assets Regulation (MiCA, Regulation (EU) 2023/1114) says services provided "in a fully decentralised manner without any intermediary" should not fall within its scope. Partly decentralized services remain covered. Legal commentary notes that "fully decentralised" has no fixed definition and that ESMA expects case-by-case assessment.
Before you use a DeFi app
- Write down your seed phrase offline and never type it into a website.
- Read what a transaction does before you sign it. Fees are charged even when it fails.
- If you borrow, find the protocol's liquidation threshold and how far your collateral's price can fall before you reach it.
- Look for the protocol's own documentation and audits. Do not rely on social media summaries.
For another common DeFi activity, see how crypto staking works, from rewards to risks.
Limitations: rules and mechanics differ by protocol and country, and TVL figures are a dated snapshot. This article explains how DeFi works and is not investment advice.
