Defuse literally means "to remove the fuse." It has come to mean generally "to disarm" or "pacify."
Diffuse is normally used as an adjective meaning "spread out," "extended," or "verbose." As a verb it means "to spread out in all directions."
Incorrect: Diffusing Family Arguments
(A title. Spreading them out?)
Correct: Defusing Family Arguments
(Ah! Unfortunately, the first example is a published title.)