We are PolkaDeFi by Polkadotters and our main mission is to bring news, opportunities, etc. from the DeFi area. We are here for everyone who is deeper into cryptocurrencies (and especially the DeFi topic). Today’s series will be dedicated to the basic concepts that we find the most important to understand the logic of the Dotsama network.
DeFi
Let’s start with the absolute basics. What is DeFi? Well, DeFi stands for decentralized finance (De + Fi). In our view, DeFi is a space where you can perform financial operations with your cryptocurrencies at a decentralized level (i.e. without the need for the existence of intermediaries, various registrations, proof of identity or origin of property).
The opposite of DeFi is the so-called CeFi (centralized finance) — a traditional financial system you are probably familiar with (e.g. banks, insurance companies, management companies and their services / products). In other words DeFi is system is (or could be) institutionless solution, whereas CeFi is always connected to some extent with institutionalization. In our opinion, the biggest advantages of DeFi are mainly:
● above-standard yield
● wide offer
● freedom
● independence
● innovative possibilities
On the other hand, there are a number of pitfalls in DeFi that cannot be underestimated. First of all, DeFi (as well as the entire cryptospace) is an experimental environment. It is a fast-growing and relatively young industry. Despite the efforts of developers, there are various bugs and instabilities that many times abuse various entities in order to enrich themselves or just draw attention to themselves.
Along with inattention or incorrect access, the DeFi users thus face many pitfalls that can lead to losses or even debts to crypto-exchanges or individual DeFi protocols. Not to mention the amount of frauds, attacks and other dishonest acts against users. It is therefore important to realize that each user in the cryptospace is responsible for himself. Cryptospace tolerates all gains, but also losses. We believe that thanks to us, users avoid mistakes and will be profitable from the DeFi options that they take advantage of. As we used to say: Create your cryptoimpery but with caution!
Dotsama
Despite the fact that we are PolkaDeFi by Polkadotters, we will talk about DeFi opportunities in the so-called Dotsama ecosystem. If you haven’t encountered this term yet, it stands for Polkadot and Kusama Ecosystem. Although the DeFi options on Kusama (experimental canary network for Polkadot) are very similar to those on Polkadot network, we often find small differences e.g. in functionalities, evaluations, etc.
Staking a Liquid staking
Staking is a way to use your crypto holdings or coins to earn additional rewards. Simply put, it is when a user locks funds in a cryptocurrency wallet to participate in a blockchain system based on the proof-of-stake protocol. Staking means buying and setting aside tokens used to validate transactions made through the blockchain.
In the Dotsama ecosystem the user needs to select validators to whom he delegates his DOT (max. 16) or KSM (max. 24) tokens. This brings more problems as for instance the minimum number of DOTs to be an active reward recipient, selection of active and honest validators to avoid slashing and of course those who can generate as many rewards as possible.
These challenges can be elegantly solved by liquid staking, which eliminates the process of selecting validators (the protocol selects them automatically). You will also receive compensation for embedded DOT / KSM, with which you can continue to work financially (e.g. swap, earnings, collateral staking, etc.).
The absolute improvement is to omit the so-called unbonding period, where thanks to the fully launched Dotsama ecosystem, it will be possible to exchange refunds for embedded DOT / KSM for native DOT / KSM almost immediately.
LP farms a Impermanent loss
Do you like passive income? Become a liquidity provider, put your cryptoactive assets in the liquidity pool and get interesting rewards! The advantage is that you send to “work” your tokens, instead of just throwing them in your wallet.
You will expand the liquidity of your chosen pair, support the protocol where you sent your tokens to work and thus strengthen decentralization. However, choose pools and projects where you provide liquidity carefully. Among other pitfalls, a phenomenon called impermanent loss can also occur.
From a practical perspective, an impermanent loss is a net difference between the value of two cryptocurrency assets in a liquidity pool-based automated market maker. It can happen by simply holding the assets in a cryptocurrency wallet.
Let’s explain this phenomenon with a simple example. You want to provide $ 1,000 in liquidity to the DOT-KSM pair. In our model example (DOT = $ 10, KSM = $ 100), this would mean entering 50 DOT and 5 KSM. In the event that one of these coins fires sharply or weakens in price (or a combination of these situations at once), it may happen that you would still receive a value of $ 1,000 when choosing your tokens, but in the form of e.g. 100 DOT and 2.5 KSM.
Therefore, you need to carefully consider where to put your liquidity. It very much depends on your goal. Highly paid LP pairs are usually a combination of a verified project (e.g. DOT) and a starting project, or a protocol token, or a project where you store your liquidity. The aim is to attract investors and the reward later decreases significantly.
The result can be either a successful risk — for example, that the reward was paid in several tokens whose value continued to grow and you did not lose your beloved DOT. Or, contrary, the complete devaluation of the deposit, as some liquidity providers, who in good faith provided liquidity to the LUNA-ATOM pair (until recently a highly rated and relatively stable pair) and the collapse of the old LUNA caused the “sucking” of liquidity from the ATOM part.
It is also important to consider how your liquidity is paid. It may happen that you have a fairly strong and stable couple, but the reward is paid in the form of so-called reward of a protocol / exchange token, the value of which may also experience significant price loss or unpredictable fluctuations.
So even thousands of rewards won’t help you if the market rewards the reward token with a significant price drop. You don’t have to lose your deposits, but maybe if you choose regular staking, you will earn more sustainable rewards at the end of the day. If you want to be safe, you can look for pools for your DOT / KSM that contain stablecoins, and even if you get less DOT / KSM when choosing, you can offset the “loss” by buying from the stable section.
to be continued…
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authors: Caesar & Merlin
