DeFi, short for decentralized finance, is a system of financial applications built on blockchain networks that operate without banks, brokers, or other traditional intermediaries. Instead of relying on centralized institutions, DeFi uses smart contracts to automate financial services like lending, borrowing, trading, and earning interest on cryptocurrency holdings. As of February 2026, DeFi protocols collectively hold over $90 billion in total value locked (TVL), demonstrating significant adoption despite market volatility.
How DeFi Works
DeFi represents a fundamental shift in how financial services operate. Rather than trusting institutions to hold your money and execute transactions, DeFi protocols use code and cryptographic verification to ensure that financial agreements execute exactly as programmed.
Smart Contracts: The Foundation of DeFi
Smart contracts are self-executing programs stored on a blockchain that automatically enforce the terms of an agreement when predetermined conditions are met. When you interact with a DeFi protocol, you are not asking permission from a company. You are interacting directly with code that runs identically for every user.
For example, when you deposit cryptocurrency into a lending protocol, the smart contract:
- Receives and records your deposit on the blockchain
- Calculates interest rates based on supply and demand
- Allows borrowers to access liquidity against their collateral
- Distributes interest payments to depositors automatically
- Liquidates undercollateralized positions without human intervention
This automation eliminates processing delays, reduces operational costs, and removes the possibility of discriminatory practices. However, it also means that smart contract bugs or exploits can result in permanent, irreversible losses.
Protocols and Their Governance
DeFi protocols are the applications that provide specific financial services. Each protocol typically has:
- Core smart contracts that execute the primary functions
- A governance token that allows holders to vote on protocol changes
- A treasury funded by protocol fees or token allocations
- Developers and contributors who propose and implement upgrades
Governance in DeFi operates through on-chain voting. Token holders submit proposals, discuss changes in community forums, and vote using their tokens. Passed proposals execute automatically through the protocol's governance contracts.
Major protocols like Aave and Uniswap have implemented time-locks and multi-signature requirements to prevent malicious governance attacks. Changes typically require holding periods of 24 to 48 hours before execution, giving users time to exit if they disagree with approved changes.
Wallets and Self-Custody
Unlike traditional finance, where institutions hold your assets, DeFi operates on a self-custody model. Users control their own cryptocurrency through digital wallets secured by private keys.
Hot wallets like MetaMask, Phantom, and Rainbow connect directly to web browsers or mobile apps, making them convenient for frequent DeFi interactions. They store private keys on internet-connected devices.
Cold wallets like Ledger and Trezor store private keys on dedicated hardware that never connects directly to the internet. Users sign transactions on the device, then broadcast them through a connected computer.
Smart contract wallets like Safe (formerly Gnosis Safe) add programmable security features, including multi-signature requirements, spending limits, and social recovery options.
The self-custody model gives users complete control but also complete responsibility. Lost private keys mean permanently lost assets, with no customer service to recover access.
Key DeFi Applications
DeFi has expanded from simple token swaps to a comprehensive ecosystem covering nearly every financial service found in traditional markets.
Decentralized Exchanges (DEXs)
Decentralized exchanges allow users to swap cryptocurrencies directly from their wallets without depositing funds on a centralized platform. The two primary models are:
Automated Market Makers (AMMs) use liquidity pools rather than order books. Users called liquidity providers deposit token pairs into smart contracts. Traders swap against these pools, with prices determined algorithmically based on the ratio of assets in the pool.
Order Book DEXs replicate traditional exchange mechanics on-chain or through hybrid systems. They offer more precise price execution for large trades but require higher liquidity to function effectively.
| DEX Type | Advantages | Disadvantages |
|---|---|---|
| AMM | Always available liquidity, simple UX | Slippage on large trades, impermanent loss |
| Order Book | Better price execution, limit orders | Lower liquidity, higher complexity |
| Aggregators | Best prices across venues | Additional smart contract risk |
Decentralized Lending and Borrowing
Decentralized lending protocols allow users to earn interest by depositing assets or access capital by borrowing against collateral. Unlike traditional loans, DeFi lending requires no credit checks, paperwork, or approval processes.
Overcollateralization is the standard model. Borrowers deposit collateral worth more than their loan, typically 150% or higher. If the collateral value drops below a threshold, the position is automatically liquidated.
Interest rates in DeFi are typically variable, adjusting in real-time based on utilization. When demand for borrowing is high, rates increase to attract more deposits. When utilization is low, rates decrease.
Flash loans are an innovation unique to DeFi. Users can borrow any amount without collateral, provided the loan is repaid within the same transaction block. These enable sophisticated arbitrage and liquidation strategies.
Yield Farming and Liquidity Mining
Yield farming describes strategies to maximize returns on cryptocurrency holdings by moving assets between protocols to capture the highest yields. It became prominent in 2020 when protocols began distributing governance tokens to users who provided liquidity.
Common yield farming strategies include:
- Providing liquidity to DEX pools and earning trading fees plus token rewards
- Depositing LP tokens into yield aggregators that compound returns automatically
- Leveraged farming using borrowed assets to amplify exposure
- Protocol-hopping to capture new token distributions
Returns from yield farming can be substantial but come with significant risks, including smart contract vulnerabilities, impermanent loss, token price depreciation, and protocol insolvency.
Staking: Network Security and Passive Income
Staking involves locking cryptocurrency to support blockchain network operations, primarily on proof-of-stake networks like Ethereum, Solana, and Cosmos. Stakers validate transactions and secure the network in exchange for rewards.
Native staking means running validator software and depositing the minimum required stake directly with the network. For Ethereum, this requires 32 ETH and technical expertise to maintain uptime.
Liquid staking protocols like Lido and Rocket Pool accept any amount and handle the technical requirements. In return, depositors receive liquid staking tokens (LSTs) like stETH that represent their staked position plus accumulated rewards. These tokens can be used in other DeFi protocols while the underlying assets remain staked.
Restaking is a newer innovation pioneered by EigenLayer. Users deposit their liquid staking tokens to secure additional networks and services, earning multiple layers of rewards from a single capital base.
Yield Farming vs Staking: Key Differences
| Factor | Yield Farming | Staking |
|---|---|---|
| Purpose | Maximize returns | Secure networks |
| Risk Level | Higher (IL, smart contracts, volatility) | Lower (slashing, lock-ups) |
| Returns | Variable, often 10-100%+ APY | Stable, typically 3-8% APY |
| Complexity | High (active management) | Low (deposit and wait) |
| Capital Requirements | Any amount | Varies (32 ETH for solo, any for liquid) |
| Lock-up | Usually none | Often required |
Derivatives and Synthetic Assets
DeFi derivatives allow users to speculate on asset prices, hedge positions, or gain exposure to assets they cannot directly hold.
Perpetual futures on platforms like GMX, dYdX, and Hyperliquid offer leveraged exposure to cryptocurrency prices without expiration dates. Funding rates balance long and short positions.
Options protocols like Lyra and Dopex provide the right (but not obligation) to buy or sell assets at specified prices. On-chain options enable hedging strategies previously available only to institutional traders.
Synthetic assets track the price of external assets like stocks, commodities, or fiat currencies. Protocols like Synthetix create these by having users deposit collateral and minting synthetic tokens that mirror real-world prices through oracles.
DeFi Insurance
Smart contract risk represents a significant concern for DeFi users. Insurance protocols have emerged to provide coverage against:
- Smart contract exploits and hacks
- Stablecoin de-pegging events
- Oracle manipulation attacks
- Custodial failures of centralized services
Protocols like Nexus Mutual operate as decentralized alternatives to traditional insurance. Users pool capital and vote on claims. Cover can be purchased for specific protocols, and successful claims pay out from the pooled funds.
DeFi vs CeFi vs TradFi
Understanding the differences between decentralized finance, centralized crypto finance, and traditional finance helps clarify what makes DeFi unique and where each system excels.
| Feature | DeFi | CeFi (Centralized Crypto) | TradFi (Traditional Finance) |
|---|---|---|---|
| Custody | Self-custody | Exchange holds assets | Bank/broker holds assets |
| Access | Global, permissionless | Account required, may restrict regions | Extensive KYC, geographic limits |
| Operating Hours | 24/7/365 | 24/7 (may pause for maintenance) | Business hours, holidays |
| Transparency | Full on-chain visibility | Limited, quarterly reports | Regulatory filings |
| Counterparty Risk | Smart contract risk | Exchange solvency risk | Institutional solvency risk |
| Transaction Speed | Seconds to minutes | Seconds for trades, days for withdrawals | Days for settlement |
| Fees | Gas fees (variable) | Trading fees + withdrawal fees | Commissions, account fees, spread |
| Insurance | Protocol-specific | FDIC for USD (limited) | Government deposit insurance |
| Recovery Options | None (self-custody) | Customer support, legal recourse | Customer support, legal recourse |
| Privacy | Pseudonymous | Full KYC required | Full KYC required |
Each system has its place depending on user needs. DeFi excels for those who prioritize control, global access, and transparency. CeFi bridges traditional and crypto markets with familiar interfaces. TradFi remains necessary for most everyday financial needs and offers protections that crypto cannot replicate.
For deeper comparisons, see our detailed guides on DeFi vs CeFi and DeFi vs Traditional Finance.
Major DeFi Protocols
The DeFi ecosystem includes hundreds of protocols, but a handful dominate in terms of TVL and user activity. The following represent the most significant as of February 2026.
Lending Protocols
Aave is the largest decentralized lending protocol with $26.85 billion in TVL across 19 chains including Ethereum, Arbitrum, Base, and Avalanche. Aave pioneered flash loans and offers variable and stable interest rates. The protocol uses the AAVE token for governance and as a safety module backstop.
Morpho has emerged as a major lending competitor with $5.8 billion in TVL. Its peer-to-peer matching layer optimizes rates by connecting lenders and borrowers directly when possible, falling back to pooled liquidity otherwise.
Compound Finance holds approximately $1.4 billion in TVL and popularized the liquidity mining model that sparked the 2020 DeFi Summer. Compound V3 introduced isolated markets with single-asset collateral for improved risk management.
Sky (formerly MakerDAO) maintains the DAI/USDS stablecoin system, securing billions in collateral. Users mint the decentralized stablecoin by depositing assets into collateralized debt positions (CDPs). The protocol has expanded to include real-world asset collateral.
Liquid Staking
Lido dominates liquid staking with $18.84 billion in TVL, representing the largest DeFi protocol by value locked. Approximately 29% of all staked ETH flows through Lido, generating the stETH token that has become integral to DeFi strategies across lending, DEXs, and yield aggregators.
Binance Staked ETH holds $7.19 billion, primarily serving users who prefer the Binance ecosystem integration.
Rocket Pool offers a more decentralized alternative to Lido, allowing anyone to run a validator node with just 8 ETH plus RPL token collateral. The protocol holds approximately $2 billion in TVL.
Restaking
EigenLayer pioneered the restaking category, accumulating $9.31 billion in TVL. Users deposit liquid staking tokens to secure actively validated services (AVSs) beyond Ethereum, earning additional yield streams. The protocol's approach extends Ethereum's security to bridges, oracles, and rollups.
ether.fi provides liquid restaking with approximately $5.6 billion in TVL, allowing users to maintain liquidity through eETH tokens while their assets are restaked across EigenLayer services.
Decentralized Exchanges
Uniswap remains the largest DEX with approximately $3.16 billion in TVL across all supported chains, though its cumulative trading volume since launch exceeds $2.4 trillion. Uniswap V3 introduced concentrated liquidity, allowing LPs to specify price ranges for capital efficiency. The UNI token now benefits from fee-sharing through the UNIfication upgrade. Uniswap operates on over 20 chains including Ethereum, Arbitrum, Base, Polygon, and Optimism.
Curve Finance specializes in stablecoin and pegged asset swaps, offering minimal slippage for large trades between similar assets. The protocol's vote-escrow tokenomics (veCRV) influenced numerous other protocols and spawned an entire ecosystem of "Curve Wars" where protocols compete to direct CRV emissions to their preferred pools. Curve also launched crvUSD, its own stablecoin using a novel soft-liquidation mechanism.
PancakeSwap dominates on BNB Smart Chain with significant presence on other chains including Arbitrum, Base, and zkSync Era. It combines AMM trading with lottery, NFT marketplace, and prediction market features, making it a comprehensive DeFi hub for BSC users.
Hyperliquid has emerged as a major derivatives DEX, handling billions in daily perpetual futures volume with an order book model that rivals centralized exchange performance. The platform's native L1 blockchain processes trades with sub-second latency and no gas fees for trading.
Raydium and Orca serve as the primary DEXs on Solana, benefiting from the chain's high throughput and low transaction costs to offer near-instant swaps.
Protocol TVL Summary (February 2026)
| Protocol | Category | TVL | Primary Chain(s) |
|---|---|---|---|
| Aave V3 | Lending | $26.85B | Ethereum, Arbitrum, Base |
| Lido | Liquid Staking | $18.84B | Ethereum |
| EigenLayer | Restaking | $9.31B | Ethereum |
| Binance Staked ETH | Liquid Staking | $7.19B | Ethereum, BSC |
| Ethena | Synthetic Dollar | $6.34B | Ethereum |
| Morpho | Lending | $5.80B | Ethereum, Base |
| ether.fi | Liquid Restaking | $5.60B | Ethereum |
| Uniswap | DEX | $3.16B | Multi-chain |
| Compound | Lending | $1.39B | Ethereum, Multi-chain |
Risks and Challenges
DeFi offers powerful financial tools, but users must understand the substantial risks involved. Unlike traditional finance, there is typically no recourse for losses.
For a comprehensive analysis, see our guide on advantages and disadvantages of DeFi.
Smart Contract Vulnerabilities
Every DeFi protocol depends on smart contract code. Bugs, logic errors, or unforeseen interactions between protocols can result in exploits. Historical losses from smart contract exploits exceed $8 billion.
Common vulnerability types include:
- Reentrancy attacks where malicious contracts call back into the victim contract before state updates complete
- Oracle manipulation where attackers influence price feeds to trigger favorable liquidations or trades
- Flash loan attacks that borrow massive amounts to manipulate markets within single transactions
- Access control failures where administrative functions lack proper restrictions
- Economic exploits that game tokenomics or incentive structures in unintended ways
Even audited contracts are not guaranteed safe. Multiple protocols have suffered exploits despite multiple professional audits.
Impermanent Loss
Liquidity providers on AMM-style DEXs face impermanent loss when the price ratio of their deposited assets changes. The greater the divergence from the initial ratio, the larger the loss compared to simply holding the assets.
For a 50/50 pool:
| Price Change | Impermanent Loss |
|---|---|
| 1.25x | 0.6% |
| 1.5x | 2.0% |
| 2x | 5.7% |
| 3x | 13.4% |
| 5x | 25.5% |
Impermanent loss becomes permanent if you withdraw at unfavorable ratios. Trading fees and farming rewards may offset losses but are not guaranteed to do so.
Rug Pulls and Scams
Malicious actors have exploited DeFi's permissionless nature to create fraudulent projects. Common tactics include:
- Backdoored contracts with hidden admin functions that drain user funds
- Liquidity pulls where developers remove DEX liquidity after attracting depositors
- Token minting exploits where creators give themselves unlimited token supply
- Fake websites that mimic legitimate protocols to steal wallet approvals
Warning signs include anonymous teams, unaudited contracts, unrealistic promised returns, and pressure to act quickly.
Regulatory Uncertainty
DeFi operates in a regulatory gray area globally. Risks include:
- Securities classification of governance tokens potentially requiring registration
- Sanctions compliance obligations that may apply to protocol operators
- Tax reporting complexity with limited tools for tracking DeFi activity
- Access restrictions as regulators pressure front-end operators
- Enforcement actions against protocol developers, as seen with Tornado Cash
Regulatory clarity is emerging but varies dramatically by jurisdiction. Users should understand their local rules and consult tax professionals familiar with cryptocurrency.
Technical Risks
Beyond smart contracts, DeFi users face numerous technical challenges:
- Gas price spikes that can make transactions prohibitively expensive or prevent timely liquidation management
- Bridge failures as cross-chain infrastructure remains a security weak point with billions lost historically
- Wallet compromises through phishing, malware, or seed phrase exposure
- Front-running and MEV extraction where miners or validators reorder transactions to profit at user expense
- Oracle failures if price feeds malfunction or are delayed, potentially triggering incorrect liquidations
- Network congestion during high-volatility periods when timely transactions matter most
- Composability risks where bugs in one protocol can cascade to affect others
Liquidity Risk
DeFi markets can become illiquid during stress periods:
- Large withdrawals may not execute at expected prices
- DEX slippage increases dramatically for large orders during volatility
- Lending markets may reach 100% utilization, preventing withdrawals
- Token values can collapse if selling pressure overwhelms available liquidity
Always consider exit liquidity before entering positions, especially in smaller protocols or exotic assets.
How to Get Started with DeFi
Entering DeFi requires preparation. Follow these steps to begin safely:
Step 1: Choose and Secure a Wallet
Select a non-custodial wallet compatible with the blockchains you plan to use:
- MetaMask for Ethereum and EVM-compatible chains
- Phantom for Solana
- Rabby as a multi-chain option with built-in security features
- Hardware wallets for storing larger amounts
After installation:
- Write down your seed phrase on paper and store it securely offline
- Never share your seed phrase with anyone or enter it on websites
- Enable all available security features (password, biometrics)
- Consider creating separate wallets for different risk levels
Step 2: Fund Your Wallet
Transfer cryptocurrency from an exchange to your wallet address. For beginners on Ethereum:
- Purchase ETH on a centralized exchange
- Copy your wallet address from MetaMask
- Withdraw ETH to that address
- Wait for confirmation and verify arrival
Keep some native tokens (ETH, SOL, etc.) for gas fees. Without gas, you cannot execute any transactions.
Step 3: Start with Established Protocols
Begin with the largest, most battle-tested protocols:
First DeFi interaction options:
- Swap tokens on Uniswap to understand DEX mechanics
- Deposit stablecoins into Aave to earn interest
- Stake ETH through Lido to receive stETH
Use small amounts initially. Treat your first transactions as educational experiments rather than serious investments.
Step 4: Verify Everything
Before any transaction:
- Confirm you are on the correct website URL
- Check the smart contract address against official documentation
- Review transaction details in your wallet before signing
- Understand what permissions you are granting
- Start with small test transactions
Step 5: Monitor and Manage
DeFi requires active management:
- Track positions using portfolio dashboards like Zapper or DeBank
- Monitor health ratios on lending positions to avoid liquidation
- Revoke unnecessary token approvals regularly using Revoke.cash
- Stay informed about protocol updates and security incidents
- Consider gas costs when compounding or repositioning
Step 6: Gradually Increase Complexity
As you gain experience:
- Explore multiple chains to find lower fees and different opportunities
- Try yield farming strategies with full understanding of the risks
- Participate in governance if you hold protocol tokens
- Experiment with bridges (cautiously, with small amounts)
- Learn to read smart contracts or use verification tools
- Join protocol Discord servers and forums for community knowledge
- Track your DeFi activity for tax purposes from the start
Common Beginner Mistakes to Avoid
Learning from others' errors can save you significant money:
- Approving unlimited token allowances - Always limit approvals to amounts you are actually using
- Ignoring gas fees - Check gas prices before transacting on Ethereum mainnet; use L2s for smaller amounts
- Chasing unsustainable yields - If APY seems too good to be true, it usually is
- Not testing with small amounts first - Always send a small test transaction to new addresses
- Forgetting about impermanent loss - Understand the math before providing liquidity
- Neglecting security basics - No seed phrase photos, no browser extensions from unknown sources
- FOMO into new protocols - Wait for audits and proven track records before depositing significant amounts
The Future of DeFi
DeFi continues evolving rapidly. Several trends will shape its trajectory over the coming years.
Layer 2 Scaling
Ethereum Layer 2 networks have transformed DeFi accessibility. Arbitrum, Base, and Optimism now host billions in TVL with transaction costs under $0.10. This enables:
- Micro-transactions previously impossible on mainnet
- More frequent rebalancing and compounding
- Broader user access beyond wealthy participants
- Gaming and social applications integrated with DeFi
Zero-knowledge rollups like zkSync and Scroll offer enhanced privacy and scalability, though ecosystem development is still maturing.
Real-World Asset Tokenization
Bringing traditional financial assets on-chain represents one of DeFi's largest growth opportunities. This convergence of traditional finance (TradFi) and DeFi creates what many call "hybrid finance" or "institutional DeFi."
Active developments include:
- Tokenized treasuries with protocols like Ondo Finance, Mountain, and Backed Finance offering on-chain US Treasury exposure, providing stable yields backed by government securities
- Private credit markets emerging on platforms like Maple, Goldfinch, and Centrifuge, connecting DeFi lenders with real-world borrowers
- Real estate tokenization enabling fractional property ownership and on-chain rental yield distribution
- Commodities with gold (PAXG, XAUT) and other assets tokenized for DeFi integration
- Invoice financing and trade finance using blockchain for transparency and faster settlement
Sky (MakerDAO) has pioneered RWA integration, using tokenized bonds and real estate as collateral backing DAI/USDS. By early 2026, RWAs represent a significant portion of DAI's collateral, generating substantial fee revenue for the protocol. This trend bridges traditional and decentralized finance, potentially unlocking trillions in currently illiquid traditional assets.
The RWA trend faces challenges around legal enforceability, regulatory compliance across jurisdictions, and oracle reliability for off-chain asset pricing. However, progress continues as legal frameworks develop and institutional interest grows.
Institutional Adoption
Major financial institutions are engaging with DeFi infrastructure:
- BlackRock's BUIDL fund brought institutional tokenized treasuries to Ethereum
- Banks exploring DeFi rails for settlement and cross-border payments
- Custody solutions from Fireblocks, Anchorage, and others enabling institutional participation
- Regulatory frameworks emerging that may enable compliant institutional DeFi
This adoption could bring massive capital inflows but may also pressure protocols toward permissioned or KYC-gated designs.
Cross-Chain Interoperability
DeFi currently fragments across dozens of blockchains. Improving interoperability through:
- Bridge security improvements addressing the weakest infrastructure link
- Chain abstraction hiding complexity from users
- Unified liquidity allowing seamless access to the best rates across chains
- Intent-based systems where users specify outcomes and solvers execute across chains
AI Integration
Artificial intelligence is beginning to intersect with DeFi through:
- Automated strategy management that responds to market conditions
- Risk assessment for lending protocols and users
- Fraud detection identifying suspicious contracts before funds are lost
- Portfolio optimization across protocols and chains
Frequently Asked Questions
What does DeFi mean in simple terms?
DeFi stands for decentralized finance. It refers to financial services like lending, borrowing, trading, and earning interest that run on blockchain technology without banks or traditional financial institutions controlling them.
Is DeFi safe to use?
DeFi carries significant risks including smart contract bugs, market volatility, and scams. Unlike traditional finance, there is typically no insurance or recourse if something goes wrong. Users should start with established protocols, small amounts, and thorough research.
How much money do I need to start with DeFi?
You can start with any amount, though transaction fees on Ethereum mainnet can make small amounts impractical. Layer 2 networks and alternative chains like Solana or Base offer much lower fees, making DeFi accessible with as little as $10-50.
What is TVL in DeFi?
Total Value Locked (TVL) measures the total amount of cryptocurrency deposited in a DeFi protocol or across all protocols. It serves as a rough indicator of user trust and protocol adoption, though it can be manipulated through incentive programs.
Can I earn passive income with DeFi?
Yes. DeFi offers multiple passive income options including lending deposits (earning interest), liquidity provision (earning trading fees), and staking (earning network rewards). Returns vary significantly and are not guaranteed. Higher advertised yields typically indicate higher risks.
What is the difference between staking and yield farming?
Staking involves locking tokens to secure blockchain networks and earn relatively stable rewards. Yield farming involves more complex strategies to maximize returns across multiple protocols, often with higher risks and variable returns.
Are DeFi earnings taxable?
In most jurisdictions, yes. DeFi earnings including interest, staking rewards, and trading profits are typically taxable events. The specific treatment varies by country and the complexity of tracking DeFi activity makes compliance challenging. Consult a tax professional familiar with cryptocurrency.
What happens if a DeFi protocol gets hacked?
Funds lost in DeFi hacks are typically unrecoverable. Some protocols maintain insurance funds that may partially compensate users, and some incidents have seen projects issue compensation tokens, but there is no guarantee. This is why using established, audited protocols and practicing proper security is essential.
Can I use DeFi without KYC?
Most DeFi protocols operate permissionlessly without requiring identity verification. However, converting between cryptocurrency and fiat currency typically requires KYC through exchanges or on-ramp services. Some jurisdictions may also require KYC for certain DeFi activities in the future.
What are the best DeFi protocols for beginners?
Start with the largest, most established protocols: Aave for lending, Uniswap for trading, and Lido for liquid staking. These have extensive audits, long track records, and large communities for support.
How do DeFi protocols make money?
DeFi protocols generate revenue through fees. DEXs charge swap fees (typically 0.3%), lending protocols take a cut of interest payments, and other protocols have various fee structures. These fees fund development, pay token holders, or accumulate in protocol treasuries.
What is impermanent loss and how can I avoid it?
Impermanent loss occurs when you provide liquidity to a trading pool and the price ratio of your deposited assets changes. The more the prices diverge, the greater your loss compared to simply holding. You can minimize it by providing liquidity to stablecoin pairs or correlated assets, or by using concentrated liquidity positions strategically.
Is DeFi better than traditional banking?
DeFi offers advantages including 24/7 access, permissionless participation, higher potential yields, and transparency. Traditional banking offers advantages including regulatory protection, deposit insurance, customer service, and established legal frameworks. Each serves different needs and risk tolerances.
What blockchain is best for DeFi?
Ethereum remains the largest DeFi ecosystem by TVL and protocol diversity. Layer 2 networks like Arbitrum and Base offer the Ethereum ecosystem with lower fees. Solana provides high speed and low costs. The best choice depends on which protocols you want to use and your transaction frequency.
How do I avoid scams in DeFi?
Verify contract addresses through official sources, avoid clicking links in DMs or emails, use hardware wallets for significant amounts, revoke unnecessary token approvals, be skeptical of unrealistic yields, research projects before depositing, and start with small amounts when trying new protocols.
