DeFi for Dummies-What you’re seriously missing out
How Decentralized Finance can earn you relatively safe yields.
A year ago all I thought about getting rich on crypto was this — you ape all your money into an obscure meme coin(something that’s named after a dog?) then wait for Elon Musk to tweet about it in which its price skyrockets into the moon and we all get home rich.
That idea is not only funny(and very delusional) but most of all it’s unsustainable especially if want to build genuine wealth. This method often invites way more loss than people profiting off from it.
Cryptocurrency has changed and developed so much from its inception. From the birth of Bitcoin, which radicalized finance by introducing a digital currency that was free from government or corporation to Ethereum which built on the technology from bitcoin to introduce programmable blockchains that developers can build on applications. Like with most technological inventions, people build upon the predecessor’s inventions and creates often something entirely new. Bitcoin enabled the existence of Ethereum and now, Etherium enabled the existence of Decentralized Finance(DeFi)
This is an important point. Everything that we’re about to learn in DeFi is an innovation or an improvement from the old and constrictive methods of traditional finance.
Decentralized Finance(DeFi) is an emerging form of finance that removes the middle man(banks, governments)from our everyday financial needs. Enabled by innovations such as the blockchain & smart contracts, what used to be banks & governments limiting our transactions are now peer-to-peer transactions enabled with lines of code without human biases that are found in traditional middlemen that improve security, inclusivity, cost of transactions, and our overall financial needs.
“DeFi takes the key elements of the work done by banks, exchanges, and insurers today — like lending, borrowing, and trading — and puts it in the hands of regular people.”
DeFi — simplified.
As the title suggests, this is for dummies so I’m breaking it down in simple terms on why you’re missing out on both the tech innovation DeFi is starting & what juicy yields it has to offer.
To put it simply, these are the 3 things you will benefit from engaging with DeFi:
1.) Decentralization — Derived from its name, DeFi is decentralized which in simple terms, means the absence of a central authority overseeing our financial being. The status quo with finance today is that it is riddled with banks, governments and several financial institutions that gatekeep & limit its users from complete financial inclusion.
In centralized finance, your money is being held by companies in which you don’t have full control of your funds, and privacy with your personal information isn’t exactly a luxury you can have with centralized exchanges since they monitor every movement your funds make.
In DeFi protocols, they let you have a say in the direction of the platform through governance tokens. Democracy matters in the space and when you actively involve the investors in participation you usually get a very passionate and involved community base.
2.) Inclusive finance opportunities & low fees — Contrary to popular belief, banks aren’t exactly there to serve your interests. Private banks are ultimately a business that seeks to profit off you and often this means limiting their services only to the super-wealthy. The average Joe cannot avail of the better services such as loans & other investments. In DeFi, you only need a device(mobile or PC) and an internet connection to make a wallet online. From then on, you can access pretty much all the services the DeFi protocols offer compared to the countless KYC questions and requirements you have to do in traditional banks.
Often, they give you terrible interest rates which are only around 0.5%(& this is on the generous side) which they offer to other clients for loans for let’s say, 4% interest so they keep the 3.5% different for profit. With DeFi, the lowest rates you can get are at 3% with up to 1000% with an added bit of risk. Crypto used to be risky, but what enabled minimized risks are stablecoins(which I will get into more later). These are tokens that are pegged directly to fiat currency like the dollar.(1 USDT=1 USD)
It doesn’t end there. Everyday bank services are riddled with transactions after transaction and the more transactions you do the more fees you have to pay. Even just doing a balance inquiry of your funds take a fee nowadays. In DeFi, fees are either very small or are practically nonexistent.
3.) Security by the blockchain — Defi is free from the clutches of central banks & other government entities that seek to control it. Blockchain technology is a decentralized public ledger( kind of like your bank books where your financial history is recorded) wherein transactions are recorded in code. This method gives allows people anonymity& asset ownership that’s nearly impossible to alter. And since the ledger is public, anyone can verify their transactions online just by looking at the public ledger.
Your online wallet’s access is only accessible with the keys(like your bank PIN). In DeFi, you alone have access to those keys. It assures you privacy but at the same time, you are solely responsible for the safety of your account from hackers & persons who would like to take a piece of your crypto funds.
Earning opportunities in DeFi
This is the part where people usually skip to. Each method of earning comes with its own varying risk. Here are the ways people earn with DeFi.
1.) Lending
Lending protocols like Aave are decentralized lending protocols that lend or borrow cryptocurrency without going to a centralized intermediary. Traditionally, banks ask for a lot when it comes to loans. You have to have liquid for the principal to the bank every month, plus interest on top of having a collateralized asset(ex. a car would be the collateral for a car loan). Rates are better in these DeFi protocols compared to traditional ones. Money is constantly flowing into the DeFi market.
2.) Liquidity Pools
Liquidity pools allow you to earn interest from the fees people pay when using pools in DEXs (Decentralized exchanges). In traditional markets, trades are executed once a buyer and seller are matched but with DeFi liquidity pools, you are presented with a hassle-free investment in which you don’t need to your eyes glued to the market at all times.
You earn with Liquidity pools by investing your assets in a pool of two coins in which you earn a substantial cut according to the pool’s APY (annual percentage yield)each time someone uses that pool to exchange their tokens. Let’s say you place your assets into a pool of $ATOM & $ETH. Each time a trader uses that pool, they pay a fee from which you would earn. Osmosis is a decentralized exchange that offers great APY for its liquidity pools up to 1000%.
However, there is no free lunch as you would need to be wary of a concept called impermanent loss. In the scenario that one of the tokens shot up at price in proportion to the other token in the pool, you would have profited less if you had simply held it. Nevertheless, if you want to minimize risk there’s always the option of pooling into stablecoins or investing in two solid assets(stable non-volatile coins).
Stablecoins are assets that are tied to a real-world asset like USD. So if you possess $USDT for example, 1 of that token is exactly worth 1 USD. The beauty of pooling into a stablecoin pool is that you can prevent extreme impermanent loss by investing in a pool in which a token is paired with a stablecoin. So not only are your assets relatively safe, but you earn great APYs every day.
3.) Incentives like airdrops!
Airdrops are free money. Yep, I just said that and that’s not far-fetched from what they already do in the real world.
In real-world businesses, they often give out free products for the clients to sample to showcase their qualities of the product. A vegan restaurant giving our 100% vegan cookies on the street for example. Airdrops in Crypto are like that, except they give you the money directly. Developers want the hype and the marketing gained from these airdrops.
The creation of certain platforms comes with the introduction of the governance token that comes with an excellent airdrop. Governance tokens give its users a say in the direction of the platform moving forward, so they give out free money to users who directly interact and contribute to its ecosystem. People earn crazy amounts from just simply staking & contributing to liquidity pools.
Risks in DeFi
All the benefits & gains from DeFi are due to its characteristics of being a permissionless decentralized space. But that also means that it’s susceptible to hackers, scammers & smart contract failures.
1.) Hackers & scammers
- Because DeFi is decentralized, the space invites hackers who are eyeing a crack in your defenses. This is why you have to keep your keys in a safe place and if you can afford it you can buy a hardware ledger to be safe.
- Protocols & projects that claim promises on making you rich quick, only to suddenly disappear with your money invested in their token. The DeFi space requires you to DYOR(Do your own research) on new projects before you invest in it. This includes reading their whitepaper, checking out their Twitter & other social media, and probing its developers to determine if it’s legit.
2.) Smart contract failures
- Smart contracts are basically a set of codes that automate the transactions to be carried out. These are vital to a project’s success and if there are issues with the developer’s code then it could potentially ruin the project down the road. Either investors would lose trust in the project over time or it could self destruct due to cracks in its system
- Faulty systems could enable experienced hackers to get. This is why some projects create safeguards and are well audited to prevent these events from occurring.
