What Is DeFi? How to generate profits in a decentralized finance system?
One of the most beautiful things about DeFi is the opportunities it creates for earning passive income. It has opened up a whole new financial world for users who have been starved of returns in the traditional banking system for decades. The potential to generate passive income in DeFi comes on the heels of ever-evolving platforms, protocols, and exchanges.
With decentralized finance, users can put their idle cryptocurrencies, stablecoins, and other digital assets to work on DeFi protocols, liquidity pools, and decentralized exchanges. Users can park their crypto assets and receive interest payments just like depositing funds into a banking savings account. In fact, the interest rates and rewards offered within the DeFi systems are often higher than those of traditional banks.
We’ve compiled this brief guide to help you navigate the deep waters of the DeFi world. Let’s start exploring the world of DeFi together.
What is DeFi?
Let’s start with the basics. For those who don’t know what DeFi stands for — DeFi means Decentralized Finance. In short, the notion describes financial services, platforms, and products running on a decentralized network of machines without a central authority or intermediaries. Within DeFi, no single entity (like a bank) controls every transaction. All the participants interact via peer-to-peer (P2P).
DeFi is considered an alternative to the traditional banking system due to its access limitations, high fees from central banks, and archaic infrastructure. All operations within DeFi protocols are executed through smart contracts and powered by blockchain technologies. All the rules are fixed in smart contracts that cannot be changed without raising a red flag. DeFi doesn’t require supervision, and every transaction and operation is executed automatically.
DeFi supports a wide range of financial operations like payments, loans, and transfers. With DeFi, you can do almost any banking operation, including lending, buying, borrowing, trading, and earning interest.
Using DeFi, you can access all your assets and funds via a secured digital wallet. You initiate transactions via smart contracts when you want to perform an operation within DeFi protocols. When initiating a smart contract, you and the other party automatically agree to a number of conditions. Once these conditions are met, a smart contract can be executed.
For example, you need to send funds to a particular account once a month, so this smart contract will continue performing transactions at regular intervals if there are enough funds. Once you set up a smart contract, it cannot be changed, so everything will go as planned.
Considering all these features, DeFi could become a new standard for the financial sector and create a global financial system that is independent, transparent, cheaper, and accessible to anyone and anywhere. What more can DeFi offer the financial world?
Benefits of DeFi
DeFi takes advantage of Bitcoin and expands on it by building a digital Wall Street without all the intermediaries and associated costs like banker salaries, trading floors, and office towers.
Accessibility
You don’t need to fill in tons of forms and wait for someone to approve your request — you create a crypto wallet, register an account, and get access to all the services provided, regardless of your location.
Pseudoanonimity
DeFi protocols and platforms don’t require your full name, email address, or personal data. Anyone with an internet connection and a crypto wallet can become an active member of the DeFi world. Though transactions don’t carry your name, they can be traced by entities with access. These include law enforcement, government agencies, and others.
Immutability
The decentralized architecture of blockchain technologies tamper-proofs all the data shared within the network and increases its security and audibility.
Transparency
All the transactions are verified by other users on the network and then fixed in the ledger. This level of transparency ensures that every user can access the network activity, and nothing can be changed without being flagged. What’s more, a large number of DeFi protocols and platforms are built with open-source code that any users can view, audit, and use for building their solutions.
Why is DeFi so important?
Though DeFi is still in the opening stages of its development, it has already posed a real threat to the centralized finance ecosystem. DeFi is no course to wipe out all the middlemen involved in financial transactions and replace them with a decentralized network of peers.
But this level of change is easier on paper than in the real world due to the regulatory burden. Current laws and regulations are written based on the idea of centralization. Integrating blockchain technologies requires numerous revisions of well-established procedures and mitigating additional risks.
While banks are still slow to adopt new technologies and approaches, millions of users can benefit from services introduced by DeFi protocols. Here’s how to get the most out of DeFi applications.
What are DeFi applications?
A wide range of DeFi applications is powered by Ethereum, the world’s second-biggest crypto platform. With smart contracts at the core of ETH trading, numerous DeFi applications are on the market. Here are the most popular ones:
DEXs or decentralized exchanges
DEXs are online platforms that help users exchange currencies for other currencies, for example, US dollars to Bitcoin or Bitcoin to Euros. Unlike traditional exchanges, users are connected directly with one another, so there is no intermediary or high fees. DEXs are simply a set of smart contracts.
Stablecoins
These are cryptocurrencies backed by real-world assets like gold, the US dollar, or Euro. Unlike crypto coins, stablecoins eliminate the issue of high volatility. They are like a digital version of fiat money. For example, sEURO is a stablecoin pegged to the EURO.
Wrapped tokens like wBTC
Blockchains cannot communicate with each other. This has given rise to dozens of inter-blockchain problems. For example, you cannot transfer Ethereum-based tokens to a non-Ethereum wallet. You cannot deposit any ETH to a BTC address and vice versa. This is where wrapped tokens (like wrapped bitcoin (wBTC) enter, wBTC allows users to interact with the ETH-based DeFi ecosystem. Wrapped tokens allow exploring other blockchains without buying/selling crypto coins anytime you need them.
But DeFi can offer far more than DEXs and wrapped tokens. Growing use cases around DeFi applications have opened new avenues for earning passive income and solid investment returns.
How to generate income with DeFi
The most interesting part of DeFi protocols is their ability to generate passive income by putting existing crypto capital to work. Trading, borrowing & lending, staking, yield farming, and liquidity mining can help you grow your funds. All it takes is some initial capital, a bit of knowledge, and patience. Rome wasn’t built in a day. But in time, your capital will also grow.
Staking
The Ethereum networks are transitioning to a Proof of Stake consensus algorithm that allows for staking ETH coins and earning rewards. Staking is similar to an interest-bearing savings account, but with one difference — stakers can earn rewards for validating blocks on the Ethereum protocol. While staking, all the coins remain in your wallet but are blocked for a certain amount of time. Some cryptocurrencies require at least three months of staking. During this time, you cannot withdraw your funds.
As a rule, staking doesn’t demand a large initial investment. So if you are limited in funds but still want to generate some passive income — staking may be right up your alley.
Lending
Lending is another DeFi activity that can multiply your funds. DeFi lending helps people borrow and lend funds in a trustless manner while generating substantial income. Similarly to staking, you lock crypto assets into a smart contract.
When these tokens are utilized by borrowers who pay interest, a portion is returned to the lender. Compared to the traditional banking system, DeFi enables crypto owners to become a lender and earn interest just like a bank.
The platform sets the interest rates algorithmically — the higher demand to borrow a crypto coin, the higher the interest rates are. But to take a crypto loan, users need to deposit collateral to secure a DeFi crypto loan. Moreover, the entire lending and borrowing process is governed by smart contracts, so there is no risk of a borrower failing to repay the debt. Unlike staking, you can withdraw your funds at any time.
Yield farming
Yield farming involves staking or lending cryptocurrency in exchange for interest and other rewards. In simple words, users of a DeFi protocol can put their crypto assets in a liquidity pool (LP). Then, these tokens are locked via smart contracts, and users get rewards for allowing their assets to be used across the platform for selling, lending, and borrowing.
It sounds so familiar, doesn’t it? Yield farming is similar to depositing money in a bank account and allowing the bank to use it for operations for which you get paid. But yield farming can offer higher interest rates than traditional banks.
For example, TheStandard.io offers a new approach to yield farming — it combines the yield farming of crypto and physical assets like gold. TheStandard.io enables users to generate a stable digital currency (sEURO) by locking up tangible and intangible assets like ETH or BTC and tokenized assets like silver or gold as collateral in Smart Vaults. The good news is that sEURO doesn’t suffer from price fluctuations like BTC or ETH. So yield farming with sEURO and TheStandard is low risk. Check out TheStandard.io’s whitepaper for more information.
The future of DeFi
As you can see, DeFi is slowly paving its way into the financial sector. The general idea is to decentralize financial activities and give more financial control to individuals. Apart from being the new kid on the block, DeFi has a lot to offer — from faster transactions to complete control and transparency. DeFi and TheStandard.io open the door to new and better ways to conduct financial operations. Sign up to find out how TheStandard.io is changing the world of finance.
