DeFi is a decentralized financial system built on blockchain technology, replacing traditional intermediaries with smart contracts. It includes decentralized exchanges, lending protocols, yield aggregators, oracles, derivatives, governance systems, and composable protocols that work together as a connected ecosystem.
Decentralized exchanges (DEXs) enable on-chain trading through various models like order books, automated market makers (AMMs), and intent-based execution. AMMs use liquidity pools and algorithmic formulas to determine prices, with different designs like constant product, concentrated liquidity, and hybrid models offering unique trade-offs in capital efficiency and liquidity management.
DeFi lending protocols use collateralized borrowing, where users deposit assets to earn yield or borrow against them. These protocols rely on pooled liquidity, utilization-based interest rates, and automated liquidations to manage risk. Yield aggregators automate DeFi strategies using vaults and strategy routing, but they introduce risks like smart-contract vulnerabilities and governance issues.
Oracles provide external data to smart contracts, which is critical for pricing, collateral values, and derivatives. Decentralized derivatives create synthetic exposure through collateral and margin mechanisms, while governance tokens allow users to vote on protocol upgrades and treasury decisions. Composability enables protocols to build on each other, creating new products but also introducing systemic risks.