Defi has attracted great interest in the cryptocurrency market for several years now. One reason is that it can help create passive crypto income. Decentralized finance DeFi is not a new concept for anyone who knows cryptocurrency or bitcoin. Bitcoin pushed the idea of owning decentralized assets and was a pioneer in digital assets, but over time, various protocols have been created to manage and diversify cryptocurrency use cases. Besides Ethereum, this includes entire ecosystems: Tron, Binance Smart Chain, Cardano, NEO and others.
What is DeFi?
First of all, DeFi is not a specific technology, but rather a set of software solutions. In general, DeFi is a whole paradigm based on providing financial services in line with the principles of DeFi. The main principles of the ecosystem are open-source, financial transparency and accessibility for each user.
DeFi is powered by smart contract technologies and dApps, on top of a blockchain platform that allows these smart contracts to be used. These are blockchains given as an example above allow developers to create complex algorithms for storing and managing digital assetsю All operations are carried out without intermediaries.
Decentralization of financial services is closely related to the concept of Web 3.0, which is the next stage in the evolution of the Internet. With the development of network technologies, user data ceased to belong to them, and security is regulated by a small group of well-known tech giants.
Presumably, Web 3.0 should return users the right to their own privacy. Blockchain and smart contract technologies can really compete with the traditional financial system. If only because they provide userswith equal opportunities. Over time, the development of new financial techs will become even more simple, which will lead to the explosive growth of DeFi platforms.
Decentralization is designed to ensure that there is no single weak point and to prevent complete system failure. Crypto coins provide their users with access to secure peer-to-peer trading and do not depend on any intermediaries. As a result, users can use their assets as they see fit.
It is important to note, however, that cryptocurrencies alone cannot decentralize the entire financial system. Instead, they managed to decentralize the issuance and storage of money.
Financial disruptions and stock market crashes are known to occur due to poorly managed systems controlled by central banks or third-party intermediaries. For Defi via smart contracts, these errors will rarely occur during the process, no matter how large or small.
Whereas in traditional finance, banks take money from some people in the form of deposits with a rate of 0.5%, give loans to other people at 2.5%, and put the difference in their pocket. A number of DeFi projects are eliminating banks and allowing people to borrow money directly from each other.
Initial Coin Offerings (ICO)
ICO is another implementation of the crowdfunding model. Participants finance the development of companies, usually blockchain projects, in order to receive either finance or other benefits from them in the future.
A project issues tokens for payments of their services in the future. Investors buy these tokens in the hope that they will grow as the company develops, thereby funding it. At the same time, buyers of currency do not receive a stake in the company and cannot influence decisions within it in any way, unlike an IPO.
Thus the startup issues its own money, which can then be exchanged for one of the popular crypto or fiat currencies. So the project, with the help of ICO, attracts the finance necessary for launch or development. This also allows them to monetize their services in the future and accelerate the development of the project.
Non-fungible tokens (NFT)
Blockchain technology served as the basis for more than just creating a digital money - cryptocurrency. Afterward, tokens appeared, which served as substitutes for securities. The next step was to digitize all other goods from the real world. Non-fungible tokens allow one to digitize any goods. With the help of them, you can digitize your rights to intellectual or other property, make money with your creativity or play.
NFTs, like non-fungible goods in reality, are different from each other. If one BTC is no different from another BTC, then each NFT is unique. This property makes it possible to represent information about any object in the blockchain. The NFT grants the user the right to own digital goods. A non-fungible token is a label that stores a link to any product. If you have a token, then you own the goods that are described in it. These opportunities have sparked a boom in non-fungible tokens since early 2021.
What are the pros and cons of DeFi?
So far, cryptocurrency is considered the ideal solution to the multiple problems of a centralized financial system. It reduces the number of mistakes and mismanagement on the part of a person. Centralized finance allows you to generate income by trusting your assets to major exchanges such as Coinbase, Binance or Gemini. However, in this case, there are restrictions that impose the passing of KYC and AML checks.
Due to the concept of DeFi as your own bank in a smartphone, you will not need the approval of intermediaries, like bank employees, to perform any manipulations with your money. You get constant access to finance. Operations occur without unnecessary confirmation.
DeFi is based on the idea of operating without mediators as a bank, which can reduce transaction fees, limit the ability of authorities to tamper with their assets, and access them regardless of physical location.
As an alternative competing solution to centralized finance, DeFi is pushing the boundaries of passive income. These finance systems offer higher interest rates, capital protection, and an increasingly wide range of investment models.
But, DeFi's strength can also be its weakness. All of this is very tempting, but there are risks. For example, Defi's activities may be affected by the instability of the blockchain on which the control token is built.
Also, an error or hacking of a platform's smart contract with partial theft of funds from pools. There have already been such incidents, some platforms have compensated for losses, and some have not.
Commissions when interacting with contracts will lead to the fact that for each movement you will pay a fee. Taking into account the hype, the cost of transactions in the Ether network can reach several dollars.
Therefore, before you start, consider whether you can recoup the cost of commissions. The liquidation of positions in the event of a sharp change in the value of an asset not in your direction will force you to walk on the edge. It is worth keeping an eye on securing your positions. Also, here you do not always get liquid tokens, which they promise to redeem from you after some time.
However, when there are too many tokens, the balance between buyers and sellers can shift for the worse and the value of tokens can rapidly roll down.
The lack of regulation at the moment has a benefit for anonymity and decentralization, but in case of failures in a smart contract, no one will insure you, except for the founders of the platform, so choose the system carefully.
Some DeFi Apps (dApps) You Should Know About
Uniswap is a decentralized exchange for asset management and liquidity delivery. You can become a liquidity provider by putting a couple of assets in a pool and getting a percentage of your trades.
Also in September 2020, Uniswap issued its own UNI token and donated 400 tokens to all users who used the services of the site at least once. Three days later, the UNI token exchange rate exceeded $ 8, which allowed users of the service to earn more than $ 3 thousand in three days.
The main success factor is the selection of the most relevant pair of assets, the purchase price of the assets and the time for which you supply liquidity. As a rule, to obtain some kind of profitability, you need to put liquidity for several months.
Several famous investors have invested in this project, such as Union Square Ventures LLC,
Andreessen Horowitz, ParaFi and others. People and companies like this don't invest in fly-by-night companies, which is a strong sign that Uniswap is a serious project with the future.
It is a platform for working and trading synthetic assets. The platform offers access to traditional markets with cryptocurrencies directly. Synthetix uses a native SNX token based on the ERC20 protocol as collateral for issuing a synthetic asset. All assets have collateral of hundreds of percent. This means that each financial derivative is backed by a significantly larger number of assets.
To earn money, you can supply liquidity in SNX tokens on DEX exchanges and receive a reward not only from the Synthetix pool but also for the supply of liquidity on the Uniswap exchange. Among the main market risks, one can single out a misunderstanding of the liquidity supply calculation system and the possibility of liquidating a pool with assets if the price of a token falls.
The system is one of the most popular lending protocols, allowing users to both borrow and lend crypto.
By connecting to Compound via MetaMask or another web3 wallet, the user can receive interest income.
Many people use the service to obtain leverage and trade on stock exchanges, but it is more profitable to lend funds and receive a stable percentage of profitability up to 8% per annum.
MakerDAO is one of the first dApps on the market. The project has been running on the Ethereum blockchain since its launch in 2018. The project is a smart contract platform. Its ecosystem is based on DAI and Maker (MKR) tokens. DAI is a stablecoin that provides tokens. It is issued against the collateral of crypto assets through the Maker Protocol Oasis.
The DAI rate is supported by stabilization fees and the TRFM Mechanism, together with the use of Stability Fees. It changes the rate in case of sharp market fluctuations, thereby protecting the assets. In addition, when using multiple platforms, it turns out to earn on the supply of liquidity on exchanges and receive additional bonuses for staking platform tokens.
Defi is seen as a new and optimal solution to the financial problems faced by traditional financial systems. It is even more attractive for people in the cryptocurrency community when they can generate passive income. This is one of the key factors in Defi.
Although, despite how many huge benefits Defi may have, along with its great revolution that is yet happening, Defi still needs some time to evolve to a complete state. As an investor in the crypto market, in order to avoid being scammed, you must be fully aware of each project before taking part in it.