Popular DeFi Protocols: Choosing what works for you

Decentralised finance has moved from a niche technical experiment to a multi-billion dollar ecosystem in a few short years. At the centre of that ecosystem are a small number of foundational protocols that have defined how DeFi works, attracted the majority of its capital, and become the infrastructure on which newer protocols and applications are built.

Understanding what these protocols actually do, how they generate yield, who uses them and why, and what their risks and limitations are gives you a genuine foundation for participating in DeFi with clarity rather than confusion. This resource covers the most significant protocols in plain language, without assuming prior technical knowledge.

What Makes a Protocol “Foundational”

The protocols covered in this resource share several characteristics that distinguish them from the broader, noisier DeFi ecosystem.

They have years of continuous operation across multiple market cycles, including the severe bear markets of 2018 and 2022. They have been audited multiple times by reputable security firms and have maintained their integrity through periods of extreme market stress. They hold significant total value locked that reflects genuine user trust built over time. And they have established genuine product-market fit: real users deploying real capital for real financial purposes rather than purely speculative activity.

This doesn’t mean they are risk-free. No DeFi protocol is. But it does mean they represent a meaningfully different risk profile from the average newly launched DeFi protocol, as covered in our security red flags in new crypto projects and how to spot a rug pull resources.

Uniswap: The Decentralised Exchange That Changed Everything

Uniswap is the largest decentralised exchange by trading volume and the protocol that introduced automated market maker mechanics to the mainstream DeFi ecosystem. Understanding Uniswap is understanding the foundation of decentralised trading.

Traditional exchanges, both centralised and decentralised, use order books: lists of buy and sell orders at specific prices that are matched against each other. Uniswap replaced the order book entirely with a mathematical formula and liquidity pools.

A Uniswap liquidity pool contains two tokens in a defined ratio. The price of each token relative to the other is determined by the ratio of the two token quantities in the pool, adjusted automatically by a constant product formula every time a trade occurs. Liquidity providers deposit equal values of both tokens into the pool and earn a share of the trading fees generated by every swap. Users who want to swap between the two tokens interact with the pool directly, with the price they receive determined by the pool’s current composition and the size of their swap relative to the pool.

The elegance of this model is that it requires no order matching, no counterparty, and no central operator. The smart contract is the market. Anyone can provide liquidity. Anyone can trade.

Uniswap’s governance token UNI gives holders the ability to vote on protocol changes and fee structures. The protocol itself has processed trillions of dollars in trading volume since its launch, making it one of the most used applications on Ethereum.

The primary risk for liquidity providers on Uniswap is impermanent loss, as covered in our staking vs farming and yield farming explained resources. When the price ratio of the two pooled tokens diverges significantly from the ratio at the time of deposit, liquidity providers end up with a different composition of assets than they deposited, which can result in a lower total value than a simple hold strategy would have produced.

Aave: Decentralised Lending at Scale

Aave is the largest decentralised lending and borrowing protocol by total value locked and the primary reference implementation for how DeFi lending works. As covered in detail in our lending and borrowing crypto explained resource, the core mechanics involve lenders depositing assets to earn interest and borrowers providing overcollateralised collateral to access loans.

Aave’s specific contributions to the DeFi ecosystem extend beyond basic lending mechanics.

Flash loans are a uniquely DeFi financial primitive that Aave introduced to the mainstream. A flash loan allows a user to borrow any amount of assets from Aave without any collateral, on the condition that the loan is repaid within the same blockchain transaction. If the loan is not repaid within the same transaction, the entire transaction is reversed as if it never happened. Flash loans enable complex arbitrage strategies, collateral swaps, and self-liquidations without requiring upfront capital, entirely within a single atomic transaction.

aTokens are the receipt tokens Aave issues when assets are deposited. An aToken balance increases in real time as interest accrues, rather than requiring manual claiming of interest. A user depositing 100 USDC receives 100 aUSDC, which automatically becomes 101 aUSDC, 102 aUSDC, and so on as interest compounds continuously.

Variable and stable rate borrowing. Aave offers both variable interest rate loans, where the rate changes with market conditions, and stable rate loans, where the rate is fixed at the time of borrowing, providing predictability for borrowers with specific use cases.

Aave’s governance token AAVE gives holders voting rights on protocol parameters including supported assets, collateralisation ratios, and fee structures. The Aave Safety Module is a staking mechanism where AAVE holders can stake their tokens as a backstop against protocol shortfall events, earning a portion of protocol fees in exchange for taking on this insurance-like role.

Compound: Where DeFi Lending Began

Compound is the protocol that established the template for decentralised lending that Aave and others have built on. Launched in 2018, it was one of the first protocols to demonstrate that lending and borrowing could operate reliably through smart contracts without any human intermediary.

The mechanics of Compound are similar to Aave: lenders deposit assets, receive cTokens (Compound’s equivalent of Aave’s aTokens), earn interest that accrues to the cToken balance, and can redeem at any time. Borrowers deposit collateral and borrow against it up to a defined limit, with automatic liquidation if the collateral value falls.

Compound’s COMP token, distributed to both lenders and borrowers based on their protocol activity, pioneered the liquidity mining model that became a defining feature of the 2020 DeFi summer. By distributing governance tokens to protocol users, Compound effectively paid users to use the protocol, bootstrapping adoption and creating the template that hundreds of subsequent protocols followed.

While Aave has grown to surpass Compound in total value locked and product breadth, Compound remains a foundational and well-audited protocol with a track record that spans multiple market cycles.

Curve Finance: The Stablecoin Exchange

Curve Finance is a decentralised exchange specifically optimised for trading between assets of similar value, primarily stablecoins and liquid staking tokens. It uses a different mathematical formula to Uniswap that is highly efficient for assets that should trade at or near parity, offering dramatically lower slippage and fees on stablecoin swaps than a general-purpose AMM can provide.

The practical importance of Curve is enormous despite its less prominent public profile compared to Uniswap. It is the primary venue for large stablecoin swaps in DeFi, handling billions of dollars in daily volume. Protocols that need to move large amounts between stablecoins with minimal slippage route through Curve. Liquidity providers earn trading fees that, while individually small per swap, accumulate significantly given the protocol’s volume.

Curve’s governance token CRV and the protocol’s vote-escrow mechanics, where CRV is locked for extended periods to receive voting power and a share of protocol fees, created an entire ecosystem of protocols competing to accumulate CRV voting power to direct liquidity incentives to their preferred pools. This “Curve Wars” dynamic, where protocols like Convex Finance built meta-layers on top of Curve to maximise CRV influence, is one of the most complex governance and incentive structures in DeFi.

For everyday investors, Curve’s primary relevance is as the most efficient venue for large stablecoin swaps and as a yield-generating option for stablecoin liquidity providers who want exposure to trading fees without the impermanent loss risk that comes with providing liquidity in volatile asset pairs.

MakerDAO: The Original DeFi Protocol

MakerDAO is arguably the original DeFi protocol, having launched the DAI stablecoin in 2017, years before the term DeFi entered common usage. It remains one of the most important infrastructure pieces in the ecosystem.

MakerDAO allows users to deposit approved collateral assets, primarily Ethereum and other major crypto assets, into Maker Vaults and mint DAI, a stablecoin soft-pegged to the US dollar, against that collateral. The process is conceptually similar to taking out a home equity loan: you deposit an asset you own as collateral and receive a loan in a stable form of value.

DAI is unique among major stablecoins because it is decentralised and overcollateralised rather than backed by fiat currency held by a central entity. Its value is maintained through a system of stability fees, collateralisation ratios, and a stability mechanism called the Peg Stability Module.

The MKR governance token gives holders control over critical protocol parameters including which assets can be used as collateral, the collateralisation ratios for each asset, and the stability fee rates. MKR is also used as a backstop in cases where the protocol becomes undercollateralised: new MKR is minted and sold to recapitalise the protocol, diluting existing MKR holders as a last resort.

For the broader DeFi ecosystem, DAI is important because it provides a decentralised stablecoin that is not dependent on any centralised issuer holding fiat reserves. As covered in our future of stablecoins resource, the distinction between centralised and decentralised stablecoins matters in the context of regulatory risk and censorship resistance.

Lido: Liquid Staking Infrastructure

Lido Finance is the largest liquid staking protocol and one of the most significant infrastructure pieces in the Ethereum ecosystem. As covered in our staking vs farming resource, liquid staking protocols allow investors to stake Ethereum without the 32 ETH minimum requirement and receive a liquid receipt token, stETH, that represents their staked position and accrued rewards.

stETH is widely used across DeFi: it can be used as collateral on Aave, provided as liquidity on Curve, and used in various yield farming strategies, allowing Ethereum stakers to earn staking rewards while simultaneously deploying their staked position in DeFi to earn additional yield.

Lido’s scale, it controls a substantial percentage of all staked Ethereum, has raised concerns about validator centralisation within the Ethereum network. This is a genuine systemic risk consideration for the Ethereum ecosystem that the community is actively discussing and working to mitigate through validator diversification incentives.

How These Protocols Interact

One of the most powerful characteristics of DeFi is the composability of its protocols: because they all operate on the same blockchain and share the same smart contract standards, they can be combined in ways that create new financial products from existing building blocks.

A common multi-protocol strategy: deposit Ethereum into Lido to receive stETH and earn staking rewards, deposit stETH into Aave as collateral and borrow stablecoins against it, swap those stablecoins through Curve at minimal cost, and deploy the resulting stablecoins into a Curve stablecoin pool to earn additional trading fees. This chain of interactions uses four protocols simultaneously and generates yield at multiple layers.

This composability is also a source of compounding risk. A failure at any layer in a multi-protocol strategy can cascade to the others. The liquidation risk from the Aave borrowing position, the smart contract risk from each protocol, and the complexity of managing multiple positions simultaneously all increase with each layer added. Complex multi-protocol strategies are appropriate only for experienced DeFi participants who genuinely understand each component.

Using These Protocols Safely

For investors approaching these protocols for the first time, several practices reduce risk while building familiarity.

Start with established protocols with the longest track records and the deepest liquidity. The protocols covered in this resource are the appropriate starting point. Newer protocols with shorter track records and less auditing carry significantly higher risk regardless of their advertised yields.

Start with simpler interactions before more complex ones. Depositing a stablecoin into Aave to earn lending interest is simpler than providing liquidity on Uniswap. Providing liquidity in a stablecoin pool on Curve is simpler than providing liquidity in a volatile asset pair. Build complexity only as understanding grows.

Use a dedicated wallet for DeFi interactions, separate from your primary holdings wallet. As covered in our how to secure your MetaMask wallet and advanced crypto security resources, compartmentalising DeFi activity limits the blast radius of any single compromised interaction.

Regularly audit and revoke token approvals using Revoke.cash. Every DeFi interaction grants the protocol permission to access specific tokens from your wallet. Revoking approvals that are no longer needed limits ongoing exposure.

Understand the tax implications of every action. As covered in our tax implications of staking and yield farming in Australia and lending and borrowing crypto explained resources, DeFi interactions generate multiple taxable events that require accurate record keeping.

Key Takeaways

The foundational DeFi protocols represent the infrastructure on which the decentralised financial system is being built. Uniswap pioneered automated market maker trading, enabling decentralised swaps through liquidity pools rather than order books. Aave and Compound established the template for decentralised lending and borrowing with overcollateralisation and automated liquidation. Curve optimised stablecoin trading at scale with minimal slippage. MakerDAO created the decentralised stablecoin DAI through a collateralised debt mechanism. Lido made liquid staking accessible to all Ethereum holders.

These protocols are composable by design, enabling complex multi-protocol strategies that generate yield at multiple layers, while also creating compounding risk that demands genuine understanding of each component before deployment.

For everyday investors building their DeFi knowledge and wanting to participate in these protocols with genuine understanding of what they are doing, our Runite Tier Membership provides the education, market insights, and frameworks to approach it safely and confidently. For serious investors who want personalised DeFi strategy support and direct specialist access to structure and manage multi-protocol DeFi positions, our Black Emerald and Obsidian Tier Members receive exactly that. Find out more at shepleycapital.com/membership.