In 2021 there was a lot of buzz about Decentralized Finance (DeFi) in the crypto world. In this article, we’ll give an in-depth but also easy to understand explanation of what DeFi is and how it works.
Table of Contents
- 1 What Is DeFi?
- 2 Definition
- 3 What Are The Uses For DeFi?
- 4 Popular DeFi Apps
- 5 Using DeFi For Lending
- 6 Pros and Cons Of DeFi Lending
- 7 Yield Farming
- 8 How To Get Started With Yield Farming
- 9 In Conclusion
What Is DeFi?
DeFi is an abbreviation for Decentralized Finance. The fact that this type of finance is decentralized means that it does not stand under the direction of one person or institutional body. Decisions are made by the DeFi community, which is why this type of system is popular as there are no intermediaries compared to more traditional types of finance.
Ideally, DeFi should be considered an ecosystem that allows users to invest, trade, and transfer cryptocurrency globally. The DeFi system ensures that money can be safely stored and moved while finding value.
Decentralized finance is a form of finance that does not rely on centralized financial systems such as banks, brokerages, or exchanges. This type of finance is blockchain-based and automated by smart contracts, eliminating the need for costly intermediaries.
What Are The Uses For DeFi?
DeFi can be used in several different ways, depending on how you want to use the system. Let’s take a look at how you can use DeFi.
Use your crypto assets for peer-to-peer lending. Think of it like selling stocks, the difference being that a brokerage does not manage it.
Taking Out A Loan
DeFi allows users to take out a loan without the need to fill out tedious paperwork. Short-term loans can be taken out, which most financial institutions do not offer.
The interest rates in a DeFi system are generally better than any bank or savings account. While there is no guarantee that you will earn any money on your investment, the chances are still higher than they would be if your money is sitting in a typical bank account.
DeFi platforms allow users to lend cryptocurrency and earn interest plus countless rewards multiple times a month.
Popular DeFi Apps
DeFi apps enable users from all walks of life to use their system no matter how good or bad your credit is. These popular apps can be used by any person and do not require identity checks.
Read on to find out about the most popular DeFi apps.
This lending platform is so popular because of its decentralization. Users of MakerDAO use the app to purchase the popular stablecoin, DAI.
The DAI holds cryptocurrencies such as Ethereum (ETH) as collateral until the user can repay the loan along with any fees incurred. Once the loan has been repaid, the ETH is released. There is a risk that the ETH could drop in price, and if this happens, it is sold to repay the borrowed DAI. These kinds of risks help to stabilize the app and are what makes MakerDAO so reputable.
Aave enables users to lend and borrow assets while simultaneously earning interest. It can also be used for flash loans which are short-term loans that many financial organizations are unable to offer.
This kind of transaction can be reversed at any given time, and intelligent contracts back them. Aave is one of the only DeFi apps to offer this kind of incentive, which is why it is so popular among users.
This app allows users to track the prices of real-world assets by using tokens known as ERC-20. Otherwise known as synthetic assets or ‘synths,’ users can track prices of stocks, currencies, and precious metals, including gold and platinum.
The way it works is not indifferent to MakerDAO, in which the ETH is used as collateral. With Synthetix, the collateral used is known as Synthetic Network Tokens or SNX.
Using DeFi For Lending
DeFi is also popular due to its attractive lending rates and the absence of background or credit checks from individuals. So how is this possible?
To begin lending with DeFi, users must deposit a smart contract on a DeFi platform of their choice. The deposit is then known as collateral which can be used against an array of cryptocurrencies that will be agreed on the smart contract.
Before lending, it is imperative to do your research as stable currencies may not offer as much of a return as more risky choices.
How Is It Different From Traditional Lending?
The first issue that springs to mind when comparing the two is the long-winded form filling and credit checks. Secondly, the return rates from lending through DeFi can be much bigger than any loan taken out through traditional lending.
DeFi offers the same products and services as traditional lending – without the hassle.
Pros and Cons Of DeFi Lending
Quick and Easy
Loans can be applied for and approved much quicker than they ever could be in traditional finance. Once granted, users have access to the funds immediately. This rapid processing is down to cloud technology which helps seek out fraudsters as well as other risks.
DeFi lending is attractive due to its constant loan approval for users; this signifies trust between the platform and its users, which gives peace of mind.
Proof of transactions
Although DeFi is decentralized, it does not mean it does not hold any information about an individual altogether. Blockchain technology can provide records of all financial transactions between the platform and a lender, including agreed rates and policies on a loan approval.
Flash Loan Attack
Taking out a flash loan leaves you vulnerable to possible cyberthief attacks that can be pretty ugly depending on the size of the loan. When an attack happens, the hacker uses the loan to manipulate the market whichever way they choose.
Although DeFi is a popular lending service, it still has some way to go before it is regulated enough to protect users from hackers and cyber thieves.
A DeFi rug pull happens when a new token is developed before the project is abandoned. The developers then pull a crypto scam by using newly obtained funds from early investors.
DeFi lending is widespread because it has no intermediaries, so it is so appealing, particularly for individuals who may struggle to lend from a bank.
However, once the loan has been granted, it is then on the user to take ownership of problems that may arise from fluctuating assets and funds. DeFi does not take responsibility for problems that may arise through human error, which does not work in the users’ favor.
Yield farming is the process in which a DeFi user aims to use their cryptocurrency to gain more cryptocurrency. It gives users the chance to obtain a higher yield using Ethereum based tokens (ERC-20), among others.
Otherwise known as ‘liquidity mining,’ yield farming requires funds to be deposited in a liquidity pool smart contract. Reward tokens are then quickly earned through supplying liquidity.
Benefits Of Yield Farming
Profit using stable coins
Generally speaking, investing using stablecoins is less risky as they are pegged to real-world assets with minimal fluctuation. However, there is a chance users can make a profit from stablecoins if they have funds in several liquidity pools.
Use Of Token Rewards
Investors can earn higher yields by continuously exchanging reward tokens on several DeFi platforms at once.
Income can be earned from cryptocurrency that has been left unnoticed in an E-wallet as it gains interest over time. Think of it as finding money in an old jacket you haven’t worn for a while.
Disadvantages of Yield Farming
Investors must keep an eye on their assets at all times, which can be tedious as they fluctuate constantly.
Investments can be risky, even more so in the world of cryptocurrency. Therefore, each investment must be thoroughly researched before any contract is signed.
DeFi platforms haven’t been around too long and are therefore not as safe as traditional financial institutions. Therefore, there is always the chance of a cyberattack that could lead to severe financial loss.
How To Get Started With Yield Farming
First of all, it is good to get to grips with the pros and cons of yield farming before diving in. This way, you are aware of the potential risks involved.
The next step is to select a suitable DeFi yield farming platform. Once you have got to grips with yield farming, you can always use more than one platform for yield farming. However, at this stage, it is best to stick with one.
Now you are ready to choose your cryptocurrency. It is best to stick with popular choices such as ETH or BTC as these are widely used.
After you have chosen your currency, it is time to download a wallet. The most popular wallets include Wallet by Coinbase, Argent, Metamask, and Trustwallet. Keep the details of this wallet safe as you never know when you might need them.
The last step is to transfer your cryptocurrency into the wallet before heading over to the dApp section, where you can now begin farming.
Decentralized Finance (DeFi) is a popular platform that enables users to trade, invest and send currency globally. The beauty of DeFi is that anybody can use it without the need for tedious form filling and lengthy background or credit checks.
If you consider using a DeFi platform, it is essential to weigh up the advantages and disadvantages before lending or investing in currency.