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DeFi

DeFi has revolutionized the way we approach traditional finance. Explore the different DApps within the crypto ecosystem and learn how to to earn rewards through DeFi.

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 was one of the biggest buzz words in 2020 and 2021, especially in the world of crypto. DeFi tokens at one point were the best performing digital assets, with numerous seeing huge gains. But, crypto traders and normal folks alike are still struggling to comprehend what DeFi is all about.

Decentralized Finance (DeFi) is a financial service using cryptocurrencies that can be programmed through smart contracts to build exchanges, lending services, insurance services, and more without centralized authorities. 

Just like cryptocurrencies, DeFi takes away the need for a centralized entity. But the way it works remains baffling even for advanced traders. Read on to find out how DeFi works, and let’s decipher the truth if you can make money from DeFi? 

Centralized Finance (CeFi) vs. Decentralized Finance (DeFi): The Differences

The financial system and services today are usually centralized. For example, banks, insurance companies, investment services are controlled or offered by a centralized entity or a person. In other words, your funds in a centralized exchange are managed by a responsible party. It is up to the entity to decide the trading fees you should pay or manage your transactions and activities.

Although CeFi and DeFi aim to facilitate the use of cryptocurrencies for different financial needs, they both are executed differently.

Decentralized finance is an open system of finance, which through blockchain technology, allows for the facilitation of financial services from peer-to-peer and gives people full control of their assets.

Stipulations for such an agreement on a decentralized application (DApp) can be written in code onto the blockchain through smart contracts. So when the stipulation for the loan is met, the funds will be released. This is just one of many functions Dapps serve. They work in the way that regular applications would, but they are entirely decentralized and without a centralized control based on one single entity. 

DApps are built on an open-sourced distributed platforms and a decentralized peer-to-peer network where no one has control over the network. It enables you to buy, sell, trade, lend and borrow cryptocurrencies on a decentralized network.

These applications are usually programmed on a platform like Ethereum to write automated code (smart contracts) and derive the rules on how the financial services will work in a decentralized manner. Once it is programmed, they are immutable, meaning no one will have control over the rules except what was written in the smart contracts.

There are various types of DApps in existence, catering to the many different needs of users. Here are some of the main ones. 

, you can do what you probably expect – borrow and lend cryptocurrencies. While the loan agreement is arranged through a smart contract. From the lender’s point of view, using these DApps has the advantage of being able to earn interest on the crypto you lend, and due to over-collateralization, there is only a minimal risk of the assets not being repaid.

From the borrower’s point of view, using these DApps has the advantage of there being no credit checks, low transaction fees, and instant settlement. 

Examples of borrowing and lending DApps: 

Through decentralized exchanges (DEXes), users can trade digital assets amongst each other without the need for a central entity to hold their funds or to deposit funds in the first place. Users instead link their wallets to the exchange and then verify the transaction themselves. 

, users can also provide liquidity to the exchange for an incentive (a proportion of the trading fee shared amongst all the liquidity providers). On other exchanges such as 

, users can also earn additional incentive rewards, usually the DEX token, on top of the trading fee. Using this method to add to the liquidity pool negates the issue of being reliant on market makers to provide liquidity. Such reliance would be impractical on the Ethereum blockchain because of its low throughput for transactions. 

The price of assets on DEXes is commonly determined by automated market makers (AMM), protocols written into the smart contracts of the blockchain which use mathematical formulas to determine the price. 

An advantage of DEXes is that because of minimal maintenance; trading fees are also minimal. Additionally, as long as the smart contract is robust, they are considered very safe. 

A disadvantage is that, compared to more established, centralized exchanges, which may offer – as Bybit does, for example – derivatives and 

, they often lack in the variety of trading that they offer.

Sophisticated investors from traditional finance who are familiar with derivatives will be pleased to know that there are also decentralized derivative platforms. A derivative is a type of contract that derives its value from the price of the underlying asset. 

The most popular derivatives are perpetual contracts, options, and futures contracts, which already have decentralized counterparts in DeFi. 

Similar to decentralized exchanges, users self-custody their own fund and allow for anonymous trading, offering privacy to users who desire it. 

These platforms often use USDC as collateral which removes the counterparty risk of a centralized platform as well. 

However, the user experience, variety of tokens, tools, volume, liquidity, and customer service is often better on centralized exchanges such as Bybit.

Investors can enjoy peace of mind by taking out 

 to cover their digital assets. This can cover the eventuality of a bug on a smart contract, for example, or a hack on the blockchain. On the other hand, some Dapps also provide insurance for actual events in the same way typical insurance would, like for flight delays. 

Through its open-source technology, DeFi offers safe payment solutions for private individuals and businesses. Blockchain technology helps prevent fraud, gives banking services to those previously unbanked, offers payment in different cryptocurrencies and digital tokens. Best of all? It allows instant processing times. 

If you want to predict the event’s outcome for money, you no longer need to go to a bookmaker. DeFi is the solution. You can predict the results of elections, sports events, and even future developments in the world of crypto. 

 are cryptocurrencies pegged to the price of a stable asset, such as the US dollar. By offering price stability and low volatility (two factors that can notoriously plague cryptocurrencies), they reassure users when performing transactions on DApps. 

Stablecoins play a fundamental role in different areas of DeFi. One of them is with liquidity pools. Stablecoins are a preferable choice because it provides stability, and hence more liquidity. Also, the lack of volatility in stablecoins provides opportunities for steady yields for investors in DeFi.

To use DApps, users will need somewhere to store their cryptocurrency and tokens. That’s where wallet Dapps come in. They are downloadable as an add-on on your internet browser. Users can also sync up their wallet Dapps with other Dapps to make transactions quick and easy. 

To perform transactions on DApps, you need tokens – not actually cryptocurrencies themselves. On the 

 network, you use Ether to gain access to these tokens, like how you use real money to get tokens for an arcade machine. But just like you use the tokens to play the games, you use the tokens in the former case to use the DApps in some ways. Just like with cryptocurrencies, tokens can be traded and fluctuate in value. 

Tokens can have different features within a DApp, and some may fall into more than one category:

 network hosts most DApps (although a significant minority exists on other networks, such as EOS, NEO, and Tron). Launched in 2015, its creator Vitalik Buterin had become frustrated with the limitations of the Bitcoin network to build DApps, and so envisaged Ethereum to go beyond just being digital money.

Ethereum’s more advanced technology (as compared to Bitcoin) allows for the implementation of these Dapps. However, the launch of more sophisticated DApps causes the network to face scalability challenges in coping with the extra demands. As a result, the 

 upgrade on the network is here to address the issue. 

Here are some of the main terms associated with DeFi that you should know. 

As its name suggests, DeFi offers a decentralized alternative to the centralized infrastructure of finance. The nature of decentralization allows the distribution of planning or decision making to stray away from the authorities or a central group. Another key benefit of being decentralized is that most protocols cannot be shut down, and are always online, accessible by anyone anywhere in the world to use.

DApps form the backbone of DeFi. They operate in the same way that regular apps do but do not run by a single entity. The functions of these DApps in DeFi range from borrowing, lending, insurance, and payments – to name but a few.

As discussed in the article, DEXes allows users to trade digital assets peer-to-peer. In contrast to centralized exchanges, they are in complete control of their funds at all times. 

Liquidity pools remove the need for DEXes to rely on market makers for liquidity. Whereas users provide liquidity in exchange for incentives. These can be trading fees, interest, bonuses, or other incentives unique to the exchange. 

Just as lego has composability (can be put together in different ways), so do DApps in DeFi. That means you can mix and match other DApps for various functions. 

The vast majority of DeFi Dapps are open-source. That means coding is available for anyone to see and interact with, and scrutinize as they see fit. 

Over-collateralized loans form a fundamental part of the DeFi infrastructure. In the absence of credit checks, they are a form of insurance for lenders if the borrower defaults on any loan on a DApp. 

However, a key difference to normal collateralization of a loan is that, in DeFi, you need to over-collateralize. This means that the borrowers would need to put forward more in assets than the value of the loan itself. The minimum collateralization ratio is 150%. For example, if somebody wanted to borrow $200 of DAI, they would need $300 of Ether to back it up as collateral. That is to protect against potential price volatility in the market. 

DeFi allows anyone to take part. You don’t need a bank account. All you need is an internet connection so you can use the DApps. 

A smart contract is a self-executing contract written onto a code of a blockchain. They execute when specific stipulations are met. Examples include loan agreements, insurance agreements, or the sale of a house. 

This is the process of converting real-world assets such as loans, or real estate, into programmable data to be stored on a blockchain. By cutting out the middleman, it takes away many of the overheads and administrative costs, which are usually involved in such procedures. 

This is a measurement used to gauge the size of the DeFi industry. It is the total value in dollars locked into DApps in the capital. For example, this capital may be liquidity in a DEX trading pool or a loan on a borrowing and lending Dapp. The TVL in DeFi has increased significantly from the early days. In January 2020, it only was around $600 million, but this had 

 to over $19 billion by December 2020, and again exploded in 2021, shooting as high as 

 by December 2021, before falling back down to $140 billion in June of 2022. 

You will probably come across this term when looking at various DeFi protocols. 

 is the annualized rate of return by compounding the rewards that you earn, while APR is the simple interest you earn without compounding the rewards that you earn. 

This is one way of making profits while supporting the DeFi ecosystem through the borrowing, lending, and exchange of tokens. As a 

, you’ll be providing liquidity to the liquidity pool with an underlying mechanism in exchange for incentives, often in the form of the DApp’s governance token. 

However, yield farming can be risky due to 

 and poor price performance especially if farming with 

, so do read up more of our articles to get a better idea if yield farming is something you should consider!

The short answer is yes, but as with anything when you’re trying to make money, it comes with a risk. 

There are numerous ways in which investors can earn a passive income from DeFi:

 is one of the main ways to make money from DeFi. As with all things DeFi, it is still a relatively new concept, but it exploded in popularity through the summer of 2020.

It involves the lending of crypto assets, namely ERC-20 tokens and stablecoins, for the purposes of providing liquidity to the DeFi ecosystem. This is done on DApps, with users earning fees or interest in crypto in return. Let’s look at a few of the most popular platforms on which you can take part in yield farming: 

This platform is one of the most popular for yield farming because of the relatively simple way it can be done. To encourage the use of the DApps (and therefore providing liquidity), users receive the COMP token, specific to the DApp (the more you use it, the more tokens you get). From the investor’s point of view, they hope that these tokens’ value appreciates over an extended period.

In COMP’s case, it did – and massively – in a concise space of time. Since its release on June 18, 2020, with a price of $61. By June 21, 2020, it had rocketed to $372. Since then, it has depreciated and become relatively stabilized around the $100 mark (as of early November 2020). However, it had seen some price spikes (most notably in early September, when it surged above the $250 mark).

What Is DeFi? (A Beginner’s Guide to Decentralized Finance)

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