DeFi (Decentralized Finance)

In one minute

• What is DeFi? A set of on-chain services — swapping, lending, stablecoins, yield — powered by smart contracts.
• Why it's different: Rules are transparent and enforced by code. Anyone with a wallet can participate.
• You'll need: A wallet, some native coin for gas, and the correct network selected.

Heads up: Educational only — not financial advice. DeFi has smart-contract, market, and operational risks. Start small.

Core building blocks

How a token swap works (step-by-step)

1. Connect your wallet to a DEX front end.
2. Choose Token A → Token B. The app quotes a price and expected slippage.
3. If Token A is an ERC-20 (or similar), first approve the DEX to spend a limited amount.
4. Confirm the swap transaction. The AMM adjusts pool balances and you receive Token B.
5. Pay gas and a small DEX fee that goes to liquidity providers (LPs).

Tip: For new tokens, add the exact contract address to your wallet to see the balance.

Liquidity pools & impermanent loss (IL)

LPs deposit two assets (for example, Token A and Token B) into a pool. Traders swap against it. LPs earn fees, but the mix of tokens changes with price.

• Impermanent loss: If one token price moves a lot versus the other, your final mix can be worth less than simply holding both. Fees can offset IL, but not always.
• Simple example: You add $500 of A and $500 of B. If A doubles while B stays flat, the pool sells some A for B to keep balance. When you withdraw, you hold less A than if you just held. Fees may or may not make up the difference.
• Concentrated liquidity: Some DEXs let you provide liquidity only within certain price ranges (higher fees if price stays in range, but more active management).

Lending & borrowing (what to know)

• Collateral: Deposit a token as collateral, then borrow another token against it.
• Interest rates: Change with supply and demand; may be variable.
• Liquidation: If collateral value falls below a threshold, the contract can sell it to repay your loan.
• Stablecoin mints: Some protocols let you mint a stablecoin against crypto collateral. Watch collateral ratios and peg stability.

Bridges & cross-chain moves

• Canonical bridge: The official bridge for a chain or Layer 2. Usually best integrated.
• Third-party bridges: Can be fast and multi-chain, but add smart-contract and operational risk.
• Best practice: Test with a tiny amount first, verify URLs, and keep gas on both sides.

Costs & confirmations

• Gas: Pay in the chain's native coin. Busy networks lead to higher gas prices.
• Routers/aggregators: Some DEXs route your trade across multiple pools to improve price; you still pay one transaction.
• L2s: Layer 2s reduce costs by batching transactions and settling to an L1. See Layer 2s.

Risks & how to manage them

Mitigations: verify contracts, use small tests, diversify, watch announcements, and consider protocols with multisigs and timelocks.

Simple checklists

Before swapping

• Correct network selected in your wallet?
• Official token contract address confirmed?
• Slippage set sensibly? (Too high can accept bad prices.)
• Enough gas for the action and any follow-ups?

Before providing liquidity

• Understand impermanent loss and fees for this pair.
• Is volume or liquidity healthy, or is the pool thin?
• Are rewards locked or subject to changing emissions?

Before borrowing

• Borrow less than the max; leave room for price swings.
• Know liquidation thresholds and penalties.
• Track interest rate model (variable vs fixed, if offered).

Educational content only. Do your own research.

Quick glossary

• AMM: Automated Market Maker. Pricing by a formula using pool balances.
• LP: Liquidity Provider. Deposits assets into a pool and earns fees or rewards.
• Slippage: Difference between the quoted price and the executed price.
• Oracle: System that brings off-chain data (like prices) on-chain. See Oracles.
• TVL: Total Value Locked, a rough size metric — not a safety score.
• Allowance: Permission for a contract to spend your tokens up to a limit. Revoke when not needed.