What is Defi Anyway?
A Crash Course
DeFi Defined
Decentralized Finance, DeFi, can be defined as a permissionless peer to peer ecosystem that allows for financial transactions to occur without the need for a central point of authority. This is done through the use of smart contracts that act in place of traditional institutions, which are in the simplest sense computer code that facilitate these interactions. Ethereum is the most widely used base layer L1 upon which countless cutting edge applications have been built, and there is no slowing down in the continued evolution being built on Ethereum, other L1’s, and L2 scaling solutions.
Before crypto existed, if you needed a loan you went to a bank (or a very generous friend). If you wanted to buy Apple stock you needed a brokerage. But in just the last couple of years that has all changed. What this means is for almost all of your financial needs, crypto provides a solution that bypasses the need to deal with the unfair practices and bureaucracy of the traditional banking system. Compare wiring money via a bank to its crypto alternative. A wire will take days and often times it would even stall to question where the funds came from, where are they going, what is their purpose, and every other privacy intruding question the bank could ask. But now? It’s a click of a button and a handful of block confirmations away. So let’s take a look at some of these decentralized applications DApps you need to be aware of that make this all possible and what you can do with them.
MAKER DAO
Maker is a protocol that allows you to collateralize your crypto holdings and generate Dai, a stablecoin pegged 1:1 to the US dollar. In order to do so you need to open a collateralized debt position CDP through the Maker portal and provide over-collateralization compared to the amount of Dai you are looking to create.
This is one of the oldest and most stress tested protocols in all of DeFi. Its importance to this space cannot be overstated as it is the first stablecoin that was backed not by fiat in a bank, but by another crypto asset.
AAVE
Aave is another OG platform that currently has $15,000,000,000 AUM. It allows for people to lend/borrow individual crypto assets. This means you can either deposit a token and earn interest on payments made by borrowers, or deposit a token as collateral in order to borrow a different one. However doing the latter means keeping a close eye on prices of the underlying asset you deposited because even though you are required to initially over-collateralize your borrow, the volatility of markets can cause your position to get liquidated if price drops too low.
CURVE
Initially Curve began as a like-kind automated market maker AMM that allows for the swapping of two similar tokens. For example lets assume you hold USDC and it’s valued at $1.01, which is a normal fluctuation in price for a stablecoin. You could opt to swap it for USDT if it was priced below $1 under the assumption that over time both tokens would normalize towards almost exactly $1 in a trade known as arbitrage. Curve has now expanded towards additional features, but like-kind trades are its bread and butter. The best part? Being a liquidity provider LP and earning yield.
There are many stablecoins on the market today (USDN, USDT, LUSD, etc.) and they need markets in order to allow for their usefulness and peg to be supported. Using Curve you can currently earn anywhere from 5% to 25% APY by simply depositing a stablecoin, a version of BTC on ETH, or ETH itself. Curve has become one of the true pillars of DeFi and the cornerstone of yield farming on Ethereum.
YEARN
Yearn is primarily a yield optimizer created by none other than Andre Cronje. It allows you to take your token or LP position and deposit it on their platform for a true “set it and forget it” LP experience. This means you take advantage of auto-compounding of rewards, which is especially helpful for people who are farming with less than 6 figures in any given pool. For a fee Yearn does all this through the use of community strategists, developer oversight, and smart contracts.
Suppose you want to provide liquidity in the USDN pool on Curve. You would first need to approve the spending of your token, deposit the token, stake it in the gauge to earn rewards, claim the rewards, sell it for your original asset, then redeposit into Curve. Sounds daunting? It can be, and very, very expensive. However with Yearn you can skip every step after depositing your token and instead deposit it on their platform. They then take care of the rest.
Uniswap — SushiSwap — QuickSwap — Pancake Swap
These are all known as decentralized exchanges, or AMM’s. Sparing you the details of how AMM’s work under the hood, they allow for decentralized exchanges of any asset on the chain on which they operate. These are critical as they allow you to self-custody your tokens, not relying on an exchange to hold your assets for you. As they say, “not your keys, not your coins.”
Popcorn
Popcorn is an example of what I like to call a level 2 yield farm/optimizer. What this means is that while it doesn’t have an underlying exchange such as Curve, it instead leverages yield farming opportunities for its users all while allowing you to farm their native token. This is different from what Yearn does in that strategies are more narrowly focused to do the legwork of finding the best returns with the least risk in a more curated scope of offerings. As a yield farmer, these farms are a dream and among the highest returns because you simultaneously farm their governance token that is provided as a reward for use of the platform.
Potential Pitfalls
While crypto provides exciting new opportunities, it also comes with its own risks and responsibilities. Crypto is all about self-custody and self-responsibility. If someone gets hold of your seed phrase your money is gone and there is no one who can get it back. Sent ETH to the wrong address? Out of luck. If you put your funds into a platform that got hacked or rugged, then its time to delete that amount from your portfolio tracker. What I am trying to convey is the old adage NEVER PUT IN MORE THAN YOU ARE WILLING TO LOSE. People hear this often, but don’t take it to heart. Pause for a second and let the following be your central guiding principal:
Never put in more than you are willing to lose, with the very real understanding you can lose it all. All actions you take are your own responsibility whether they result in riches or ruin, with nothing you read/see/hear from Farmer Bob or anyone else being financial advice
Never forget this as you explore this space. You alone are responsible for every decision you make and the results.
Endgame
What is the endgame of all of these incredible financial wonders? For sophisticated investors, it might be arbitrage or leveraged trading of assets. But for yield farmers the goal is to put your money to work. Whether that’s via simple lending out of single assets, something more nuanced such as being a liquidity provider, or even more sophisticated and higher risk methods. More sophisticated examples we will look at later such as using your BTC to borrow stables for short to medium term yield farming, before ultimately repaying your loan. But as with anything in life, it is best to get your feet wet before jumping into the deep end of the pool.
So you want to be a yield farmer?
Next week we are going to do a deeper dive into the mechanics of yield farming because we all want to know where these crazy returns actually come from and how to take advantage. But before that you need prepare yourself. Here is a little to-do list that every person should complete before they dive head first into crypto.
1. Set up an account with an exchange that provides for a fiat on-ramp/off-ramp. Whether its FTX, Coinbase, Binance, Gemini, you need to have an account that allows you to put your fiat dollars into crypto.
2. Exchange your fiat dollars for a stablecoin such as USDT, USDC, Dai, BUSD, or another one you’re comfortable with. However those are considered the big 4, most battle tested, and well established stables in the space.
3. Get yourself a Ledger or Trezor. In crypto, safety is of the utmost importance and a cold wallet along with proper security measures is king.
a. NEVER give anyone your private key. I don’t care if your dad asks you for it, no one gets your private key.
b. NEVER type your private key on your computer, phone, or anything else that connects to the internet
c. ALWAYS backup your seed phrase on paper in at least 2 places, stored separately and secretly, so that only you and perhaps a close family member know where it is in the event of an emergency.
4. Download the Metamask extension for your browser and follow the same safety protocols as outlined above. Metamask is what is known as a hot wallet, but the best way to interact with different blockchains. To increase your level of safety use your hardware wallet via Metamask and this way the important stuff is kept offline. Video How To
5. Fund your hardware wallet auto-generated ETH address, connected via Metamask, with the stablecoins you traded for on the fiat on-ramp exchange.
Keep in mind this is only the first layer of safety. Next week as we do a deeper dive into how to generate income via yield farming we will look into smart contract risk that using a hardware wallet does not eliminate, but also minimizing exposure via safe farming practices.
Alright farmers, I hope this crash course in DeFi gave a glimpse into the inner workings of this incredible technology. Delicious crops await.
***Not financial/investment advice. Always do your own research.***
