How DeFi works

DeFi combines blockchain records with programs that apply predefined rules. This page looks at the relationship between addresses, contract instructions, and the information those programs use. The descriptions explain how systems are organized, without directing readers to a provider or a transaction.

Records and instructions

Blockchain data describes the records kept by a network

A ledger links accepted transactions to the balances and contract information stored within the same network.

A ledger contains accepted transactions and the state produced by processing them. An address identifies an entry point for activity, while a transaction identifier refers to a particular record. A public record can be visible without containing the real name of the person behind an address. Visibility therefore differs from identification. Reading a transaction also requires context: its date, the contract involved, and the type of instruction all help explain what the record represents.

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Contract logic describes the instructions processed by a program

A contract connects defined conditions to the actions its code can perform using the inputs available.

A contract applies its programmed conditions to the information supplied in a transaction. It may record a balance, check a permission, or send an instruction to another contract. The term smart contract describes this software function; it does not mean that the program understands circumstances beyond its inputs. Code can contain errors, and a permitted instruction may still have consequences that a person did not intend. Execution and human interpretation are separate parts of the subject.

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Information inside and outside a chain

On-chain data is information recorded within the blockchain. It includes transactions, contract state, and other entries recognized by the network. A program can refer to these entries within the limits of its execution environment. Public access to records does not make every detail self-explanatory; individual entries still depend on the rules that produced them.

Off-chain data originates outside that ledger. An oracle is a mechanism for making external information available to a contract. Its sources, transmission method, and update schedule form part of the arrangement. A program that uses an oracle depends on those inputs as well as its own instructions. The ledger records processing, rather than independently establishing every external fact.

Control within a protocol

Decentralization concerns the distribution of functions and authority. Network validation, the publication of code, and permissions to alter contract settings are different questions. An application can use a shared blockchain while particular addresses retain administrative powers. Describing control requires looking at those powers and the procedures attached to them.

Governance is the process through which decisions about a protocol are made. Some arrangements use token-based voting; others assign roles to a group of participants. A vote may concern a parameter, a software version, or the handling of a shared resource. The procedure for recording a decision is distinct from the procedure for putting it into practice.

Applications can also depend on other applications. A contract may call another contract or refer to an external data feed. This connection is often called composability. It describes how software components interact, including how one component can depend on another. These definitions provide context for reading about DeFi; they are not instructions for connecting a wallet, authorizing access, or carrying out a financial activity.

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