DeFi (Decentralized Finance) is a system in which programs called smart contracts on the blockchain provide financial services in place of banks or brokerage firms. As of 2026, you can access a wide range of services similar to traditional finance—such as trading on DEXs (decentralized exchanges), lending and borrowing, and earning rewards by providing liquidity—without any intermediaries. On the other hand, there are also unique risks not found in traditional finance, such as program flaws or sudden price swings, so it's important to understand how the system works and make careful decisions.
DeFi Basics: How Finance Works Without Banks
DeFi is an open financial system built on blockchains like Ethereum that anyone can access. Users simply connect their own wallet (an app for managing crypto assets) to a service and can start trading or lending without credit checks or account opening.
Smart contracts are at the core of these services. These are programs that automatically execute contract terms, handling fund management and trade settlement in place of a bank. This setup keeps operating costs low and allows anyone around the world to use the services under the same conditions.
Main Types of DeFi Services and How They Work
DeFi primarily offers three representative services.
DEX (Decentralized Exchanges)
A DEX is an exchange where users can trade crypto assets directly with one another without a central administrator. Notable protocols include Uniswap and Curve. Unlike traditional exchanges, you trade directly from your own wallet, which reduces the risk of depositing assets on an exchange. However, this also means trades cannot be reversed, among other caveats.
Lending (Borrowing and Lending)
Lending is a service that allows you to earn interest by lending out your crypto assets. Aave and Compound are leading examples, and you can also borrow other assets using your deposited assets as collateral. Interest rates fluctuate based on supply and demand, and while you can expect higher yields than bank deposits, there is a risk of forced liquidation if the price of your collateral assets drops sharply.
Liquidity Provision (Yield Farming)
Liquidity provision involves depositing funds into a trading pair on a DEX and receiving a portion of the trading fees as a reward. The deposited funds are pooled into a "liquidity pool" used to facilitate trades for other users. While there is potential for high rewards, you may also experience "impermanent loss," which arises from price fluctuations between the two assets you deposited.
DeFi-Specific Risks and Considerations
While DeFi is appealing, it carries the following unique risks:
- Smart contract vulnerabilities: If a program contains bugs or defects, funds can be stolen or services can be halted. Large-scale hacking incidents have occurred in the past.
- Price volatility risk: Crypto assets are subject to extreme price fluctuations, and the value of deposited assets or collateral can plummet. There is also a risk of losing your principal.
- Impermanent loss: When providing liquidity, if the price gap between the two deposited assets widens, you may incur losses compared to simply holding the assets.
- Regulatory and tax uncertainty: Tax treatment and regulations for DeFi transactions and profits vary by country and region, and are subject to change. You should also check the latest information regarding Japan's tax rules.
Summary: What to Check Before Starting with DeFi
DeFi continues to evolve in 2026 as a new form of finance that operates without banks. While it offers convenience and opportunities not found in traditional finance—such as DEXs, lending, and liquidity provision—it's important to understand that the technical and price-volatility risks are equally significant.
Before getting started, it's essential to thoroughly understand how each protocol works through reliable sources, start with small amounts, and stay up to date on the latest tax rules and regulations. If you're starting with a domestic exchange, consider using the cryptocurrency exchange comparison to choose a service that fits your needs.
Risk and Disclosure
Risk: Cryptocurrency assets are subject to significant price volatility and may result in a loss of principal. This article is a general overview based on information as of 2026-10-06 and does not constitute a solicitation or recommendation to invest, nor advice on specific assets. Trading eligibility and tax treatment vary by country/region, so please be sure to check the regulations in your country of residence and the latest terms of each exchange before use.
Affiliate Disclosure: This article may contain advertising (affiliate) links, and our site may earn a commission at no additional cost to the reader. Compensation does not influence our reviews or ratings.
Frequently Asked Questions
What is DeFi?
DeFi (decentralized finance) is a system that uses smart contracts on a blockchain to offer financial services like trading and lending without intermediaries such as banks. It is open to anyone, and all transaction histories are recorded on the blockchain.
What is the difference between a DEX and a regular crypto exchange?
A DEX (decentralized exchange) has no central administrator; users trade directly with each other through smart contracts. In contrast, a regular exchange is managed by a company that holds users' assets and facilitates trades. DEXs reduce the risk of custodial loss, but trades cannot be reversed.
What are the risks of liquidity provision?
Liquidity provision can lead to impermanent loss due to price changes between the two deposited assets. There is also the risk of funds being drained through smart contract vulnerabilities, as well as the possibility of losing principal if crypto prices crash overall.
Do I have to pay taxes on profits from DeFi?
Profits from DeFi are taxable in many countries, but tax rules vary by jurisdiction. In Japan, for example, gains from crypto trading and interest from lending may be taxed as miscellaneous income. Always check the latest tax regulations and consult a tax professional if needed.
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