The financial industry is undergoing a profound transformation with the rise of Decentralized Finance (DeFi). This ecosystem uses blockchain (BC) technology to redefine traditional financial services through decentralization, transparency, and automation. Unlike Traditional Finance (TradFi), which depends on centralized institutions like banks, DeFi uses public BCs for permissionless and trustless transactions. A key aspect of this shift is the integration of fiat currencies into DeFi via stablecoins and tokenization mechanisms, bridging conventional finance and BC-based systems. This paper explores the mechanisms enabling fiat integration, such as stablecoins, tokenization systems, and BC bridges, and provides a taxonomy of DeFi protocols supporting lending, trading, and liquidity provision. It also compares CeFi and DeFi, highlighting structural, operational, and regulatory differences. The vulnerabilities of decentralized systems are illustrated through case studies like the Terra Luna collapse, FTX bankruptcy, and stablecoin depegging events. Despite its advantages, DeFi faces challenges such as scalability, interoperability, security vulnerabilities, and regulatory uncertainties. DeFi’s sustainable growth hinges on addressing these obstacles via Layer 2 solutions, cross-chain protocols, and improved regulatory clarity. Lastly, the paper discusses future research opportunities, including the integration of Central Bank Digital Currencies (CBDCs) into DeFi and the role of Artificial Intelligence (AI) in enhancing risk modeling and smart contract security.