Blockchain 101: What Is DeFi?

Forget banks. Forget permission. Say hello to decentralized finance.

SMooTH

Posted on May 17, 2025

Aha! Lovely to see a familiar face once again. 🫡

GM, friend, and welcome back to Blockchain 101 — the only series that makes explaining crypto feel just a little less nerdy than it actually is.

We’ve come a long way since our very first tutorial, but the journey’s far from over.

Not long ago, we introduced you to smart contracts — the code that powers everything from NFT sales to on-chain DAOs.

Now it’s time to tackle the biggest beast smart contracts ever unleashed: Decentralized Finance, aka DeFi.

DeFi isn’t just “banking on the blockchain.” It’s a whole new financial system — open, programmable, and very much wild.

Let’s wake those neurons up, shall we? 🧠⚡

1️⃣ What Is DeFi?

At its core, Decentralized Finance is exactly what it sounds like: finance without the banks.

Instead of needing a bank to hold your money, a broker to trade your assets, or a loan officer to decide if you're worthy — DeFi runs on smart contracts that live on public blockchains like Ethereum.

These smart contracts automate financial services like:

Lending and borrowing

Trading assets

Earning interest (often more than your bank pays)

Even getting insurance or minting a stablecoin

With DeFi, you don’t need permission, an ID or a credit check. Just you, an internet connection, your wallet, and some crypto.

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Wait, “stablecoin”? What’s that?

Great question.

Stablecoins are like digital dollars on the blockchain, designed to always be worth $1.

USDT and USDC dominate the market, offering a stable way to trade without crypto's usual rollercoaster rides. 🎢

➡️ You can read our Stablecoin 101 explainer here.

2️⃣ How Does It Work?

DeFi isn’t powered by humans in suits — it’s powered by code (big surprise, I know).

Here’s how the core building blocks fit together:

🛠 Smart Contracts

These are the brains of DeFi. They run autonomously, executing logic like “if collateral is deposited, release loan” — no human needed.

But you knew that already, didn’t you? 😉

💧 Liquidity Pools

Instead of a traditional order book, many DeFi platforms use liquidity pools — giant pots of crypto locked in contracts by users. Traders swap against these pools.

In return, the users (aka liquidity providers) earn fees.

📈 Automated Market Makers (AMMs)

An AMM prices tokens using algorithms based on supply and demand. The more a token gets bought, the more expensive it becomes — no haggling required.

A prime example of an AMM is Uniswap.

🌾 Yield Farming

Want to earn even more? Users “farm” yield by moving crypto into different platforms that offer rewards — kind of like shopping around for the best savings account… if savings accounts also paid you in memecoins and governance tokens.

🗳 Governance Tokens

Protocols like Aave, Uniswap, or MakerDAO give voting power to their users via tokens. Want to propose changes to the system? You’ll need those tokens to win the vote.

Still with me? Let’s look at a practical example to see how these all work together.

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Example

Bob wants to earn some passive income on his crypto — but he doesn’t want to sell his precious ETH.

So, he heads to a DeFi lending platform like Aave.

Bob connects his wallet and deposits his ETH into Aave. A smart contract handles everything — no banker, no waiting room.

Bob’s ETH joins a giant liquidity pool of other users’ ETH. This pool funds loans for people who want to borrow ETH.

Bob swaps some of his USDC (a stablecoin) for AAVE tokens (Aave’s governance token) on Uniswap, where an AMM algorithm sets the price. No order book, no human — just a formula.

Bob decides to stake his AAVE tokens in a special vault that rewards him with bonus tokens. He’s now farming yield like a DeFi degen (but responsibly).

Because Bob now holds AAVE tokens, he can also vote on proposals to change interest rates or add new features to the protocol.

In under 10 minutes, Bob became his own bank, investor, and voter — all from his laptop. No paperwork. No permission needed.

3️⃣ DeFi vs TradFi

Let’s see how DeFi stacks up against good ol’ banks, brokers, and red tape.

🏦 Traditional Finance

Access often requires ID, paperwork, and approval — and it’s not always available everywhere.

Your money is held by banks or institutions; you don't fully control it.

Operations are mostly closed off — you can’t see what’s going on behind the scenes.

You rely on intermediaries like bankers, brokers, and customer service to move money or resolve issues.

Regulation provides consumer protection, but slows down innovation and limits availability.

🧠 Decentralized Finance

Open to anyone with a crypto wallet — global, 24/7, and permissionless.

You hold your own keys and control your funds directly.

Transactions and protocols are fully transparent and verifiable on public blockchains.

Smart contracts automate everything — no need for intermediaries.

Innovation moves fast, but there’s less regulation and fewer safety nets.

4️⃣ Use Cases & Examples

So now that we understand what it is, how it works, and how it compares to classic finance, I’m sure you’re dying to know..

What can you actually do with DeFi?

Let’s look at some of the most popular use cases:

🔄 Trading & Swapping

Want to exchange one token for another? Uniswap, Curve, and other DEXs (Decentralized Exchanges) let you do it instantly, no sign-ups, no KYC, no waiting.

💸 Lending & Borrowing

Want to earn passive income or borrow crypto without asking anyone? Platforms like Aave and Compound let you deposit tokens and earn interest, or borrow against your holdings.

📉 Stablecoins

Don’t want to deal with crypto volatility? Use stablecoins (USDC, DAI,..) to transact in dollar-pegged tokens.

🌾 Yield Farming & Aggregators

Platforms like Yearn Finance or Beefy move your assets between strategies to find the best yield, so you don’t have to. Think robo-advisors — but for degens.

🧪 Liquid Staking

With Lido and Rocket Pool, you can stake your ETH and still keep it liquid using tokens like stETH or rETH — which you can then use across other DeFi apps.

5️⃣ Conclusion + Word of Caution

DeFi is exciting. It’s open, fast, borderless, and full of possibilities.

So why doesn’t everyone use it??

Well, there’s a couple of reasons:

1️⃣ Lack of Awareness

Most people still haven’t heard of DeFi — or even crypto beyond Bitcoin. It’s flying under the radar.

That’s exactly why this Blockchain 101 series exists: to change that.

2️⃣ It’s a Steep Climb

Once you’re in, using DeFi takes 10 minutes. But getting there? That’s another story.

For someone brand new to crypto, the learning curve is steep — wallets, networks, gas fees... it’s a lot.

That’s why many beginners go with centralized exchanges (CeFi). They sacrifice most of DeFi’s benefits — but in return, they get simplicity and speed, no homework required.

3️⃣ It’s Risky

Here’s what to keep in mind before you ape in:

Smart contract bugs: Code can break. Hacks happen.

Impermanent loss: Providing liquidity sounds great… until token prices diverge and eat your gains. And crypto still is a very volatile asset. (We will learn more about impermanent loss in a later article)

Rug pulls: If a project promises 10,000% APY and launched yesterday? Probably not your ticket to early retirement. Not every project is legit.

No helpdesk: If you send funds to the wrong wallet, or get scammed — that’s on you.

Regulatory gray zones: DeFi isn’t illegal, but rules are still being written — and they may change fast.

Rule of thumb?

Start small. Stick to well-known platforms (like Aave, Compound, Yearn, Lido). Learn how it works. Double-check everything. Never invest more than you’re willing to lose.

Because in DeFi, you’re the user, the banker, and the guard dog.

Use it wisely, experiment carefully — and if this guide helped you stay sharp in the chaos of Web3, hit that follow. More no-BS breakdowns coming soon.

Welcome to the future of finance. 🫡

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So far, in our Blockchain 101 Series: