Decentralized lending protocols allow users to borrow and lend cryptocurrency through smart contracts, without any underwriting institution, credit bureau, or loan officer involved in the process. The model replaces credit assessment entirely with collateralization — a user who wants to borrow must first deposit more than the borrowed amount in a different cryptocurrency, and the smart contract manages the rest.

The process begins with a liquidity provider depositing an asset — say, ether — into a lending protocol. That deposit is available for borrowers to withdraw, provided they first lock collateral into the same smart contract. Lending in defi generally requires over-collateralization: the collateral deposited must exceed the value of the loan, often significantly, to provide a buffer against the price volatility common in cryptocurrency markets. The smart contract tracks the loan-to-value ratio continuously, relying on oracles to feed it current price data for both the collateral and the borrowed asset.

Decentralized finance and the traditional financial system both offer lending, trading, and asset management services. The similarity largely ends at the product description. The underlying structures — how participants are identified, how transactions are authorized, how risk is managed, and who bears it — diverge in ways that carry significant implications for regulation, access, and stability.

The most fundamental difference is intermediation. Traditional finance is built on institutions that stand between parties to a transaction, holding assets, processing orders, underwriting loans, and taking on counterparty risk in exchange for fees and regulatory compliance. A bank borrower is not a direct counterparty to a depositor; both are clients of an institution that intermediates. Even in securities trading, where buyers and sellers are nominally matched, brokers, exchanges, and clearinghouses layer between the transaction and its settlement. Each of those intermediaries is licensed, regulated, supervised, and legally accountable.