Decentralized finance, or DeFi, is a broad category of cryptoasset financial services built on blockchain networks. DeFi applications use protocols and smart contracts to automate functions such as trading, lending and borrowing, rather than relying exclusively on conventional financial institutions and market infrastructure. The label does not mean every application is fully decentralized, safe or free of intermediaries.
What is DeFi?
DeFi is not one company, product or blockchain. It describes a range of applications that provide financial functions using blockchain infrastructure and software rules called smart contracts. A smart contract can execute actions when specified conditions are met; the blockchain records transactions and provides the underlying settlement infrastructure.
In its technical definition, the Bank for International Settlements (BIS) describes DeFi as non-custodial and not requiring a central organization to operate. In practice, however, ownership, governance and decision-making arrangements differ across projects. A decentralized label alone does not show who can change a protocol, control its interface or influence its operation. The BIS Financial Stability Institute’s review of DeFi discusses this variation.
How does DeFi work?
A simplified DeFi system has three layers. Users may interact with one application or combine services across several of them. That flexibility—sometimes called composability—can also connect their risks: an issue in one protocol may affect another application that relies on it.
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- Settlement layer: The blockchain network on which transactions are recorded and completed.
- Application layer: Protocols and smart contracts that carry out functions such as exchanges or lending.
- Interface layer: Websites or other tools through which users interact with the applications. An interface can make a protocol easier to use, but it is not the same thing as the protocol itself.
Automation changes how some financial activities are carried out; it does not remove the need to consider custody, governance, technical dependencies or risk controls. The BIS’s 2023 Annual Economic Report chapter on the crypto ecosystem explains both DeFi’s structure and its vulnerabilities.
What are examples of DeFi?
DeFi applications cover several familiar financial functions. These are broad categories, not endorsements of particular protocols, and they do not establish that a service is available or permitted in every location.
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- Decentralized exchanges (DEXs): Applications that let users trade cryptoassets through protocols rather than using a conventional exchange’s trading infrastructure.
- Lending and borrowing: Protocols that facilitate lending and borrowing cryptoassets.
- Derivatives: Applications that issue or trade derivative products in decentralized systems.
- Asset management: Applications that manage or allocate cryptoassets through decentralized arrangements.
- Insurance: A category identified in BIS material, though described as an early form.
- Prediction markets: Markets where participants take positions on future events, an example listed by Ethereum.org’s introduction to DeFi.
How does DeFi compare with traditional finance?
DeFi seeks to reproduce functions found in traditional finance, but the systems can differ in who holds assets, how decisions are made and how transactions settle. Comparing them requires looking at specific arrangements rather than assuming that one model is always safer or more transparent.
| What to compare | Questions to ask |
|---|---|
| Custody and control | Who holds or can move the assets? Does a central organization or a protocol control access? |
| Governance and upgrades | Who can change the software or its rules, and how are those decisions made? |
| Settlement | How are transactions completed, and what blockchain or other infrastructure does the service depend on? |
| Transparency and information | What transaction data is visible, and what information about the service, its risks and its decision-makers is available? |
| Risk controls and safety nets | What protections or safeguards apply, and what happens when a user, application or connected service encounters a problem? |
Blockchain transactions may be visible, but visibility is not the same as complete, understandable information about a protocol or its broader financial effects. Nor does automation make a service inherently safer. A BIS speech published October 3, 2025 notes that DeFi can share traditional finance’s vulnerabilities, including excessive leverage and risk taking, liquidity mismatches and interconnectedness.
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What risks and limitations should users understand?
DeFi can reproduce familiar financial risks while changing how they emerge. The BIS identifies operational fragilities, liquidity and maturity mismatches, leverage and interconnectedness as areas of concern. Smart contracts, reliance on underlying blockchains and automatic collateral liquidation can shape how losses or disruptions spread. When protocols depend on one another, a problem in one component can have consequences elsewhere. The BIS’s 2023 analysis examines these vulnerabilities.
A BIS paper published April 15, 2025 also discusses information asymmetries, market inefficiencies and the risk of cryptoisation in emerging markets. Its authors propose tailored regulatory approaches and state that their views are their own and do not necessarily represent those of the BIS or member central banks. Read the BIS paper on cryptoisation and DeFi.
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These are system-level concerns, not a claim that every DeFi service has the same risks. The relevant risks depend on the particular application, its governance, its technical dependencies and the way it is used.
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.What is known about DeFi’s size?
No dated, verified market-size figure is established by the cited sources here, so a current total should not be inferred from undated estimates. Measuring DeFi’s broader macro-financial significance is also difficult: the BIS notes that reliable information on those implications remains hard to obtain even though blockchain transactions are theoretically transparent.
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BIS Project Atlas, published March 23, 2026, is intended to improve analysis of cryptoasset flows and DeFi’s macroeconomic relevance. Its purpose signals that measuring these flows remains an active challenge, not that a definitive market-size total is already available.
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