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What exactly is DeFi and why is it such a hot topic?
Decentralized finance (DeFi) is a notion where decentralized architects can now become a platform for traditional financial instruments even outside a company or government’s control. In short, crypto entrepreneurs can now build these instruments on public blockchains like Bitcoin and Ethereum.
As the world’s financial system gains massive wealth, its centralized nature is not transparent or accessible to everybody in the world.
Fortunately, rapid technological developments and adoptions lead to the instigation of the decentralized financial system. Its emergence is the main attraction to crypto business people, making it a most discussed topic today.
Potential DeFi Use Cases
DeFi has marked staggering growth in the crypto industry in 2020, where there was already over $11 billion locked in Ethereum DeFi platforms and more than 100,000 crypto-users as of October 2020. Before interacting with any DeFi platform, know these prominent DeFi use cases allow you to par with DeFi’s dynamic changes.
Open Lending Platforms
Open lending platforms usually have decentralized applications (DApps), making them more preferable by crypto people. This platform provides digital asset lending or borrowing services to and from other crypto-users with added interest.
Borrowers should typically deposit collateral worth more than the amount loaned and must sustain their collateral more than the specific value threshold, protecting the borrower. If the borrower fails to comply and the loan-to-value (LTV) ratio falls below the level, the collateral becomes a reimbursement for the lender.
When sombody wants to maintain liquidity while evading volatility, Stablecoins is the typical choice. With its utmost stability, lenders, borrowers, traders, and liquidity providers get hooked on this DeFi method. This digital asset pegged a specific value to a different asset to reduce volatility while keeping the price stable. Some examples are:
- The US dollar (USD) or Euro (EUR)
- A variety of assets (Facebook’s Libra Stablecoin)
DeFi also lacks centralized authority, which is similar to automatic market makers (AMMs) like Curve. Decentralized exchanges, or DEXs, trading platforms use basic mathematics in setting the price in the liquidity pool’s token. A DEX can also use the ask/bid system set by its order prices.
Meanwhile, some DeFi marketplaces with a DEX-like system (i.e., OpenSea) allow users to utilize a smart-contract-based escrow system to deal with digital goods but in a dubious manner.
DeFi platforms now provide similar functionality with insurance policies, where the user has enough insurance coverage during an unforeseen accident. Decentralized insurance can be a way to protect yourself from potential destructing events like failure of smart-contact, hack, and market crashes.
However, investors in decentralized insurance share the same amount of risks in return for their insurance premium. Meanwhile, these platforms have accessible payout methods built under smart-contracts visible to the public to avoid any unclear fine print.
This DeFi use case is typically the first way how digital asset holders gain decentralized finance exposures due to its simplicity. The staking method allows users to help each other join in the network governance of Proof-of-Stake (POS) blockchains using two methods:
- Through the validator node’s digital asset delegations
- Via a compatible wallet to store digital assets
The more the users help secure blockchains through asset staking, the more the rewards they can earn, delivered automatically by the network.
Why Should I Care About DeFi?
DeFi methods and products are inherently transparent due to its platforms built using uncensorable networks and open-source software, making it accessible to anyone with an internet connection.
DeFi has the power to connect various people worldwide, engaging in financial activities like borrowing, spending, betting, lending, and trading) without relying on any intermediaries. Although the DeFi concept is still premature, its convenient and sufficient processes introduced a new financial model that is:
It is evident that today’s global financial system has flaws caused by excessive borrowing and opacity, so it must provide an alternative through a decentralized finance way.
Earning money with Yield Farming
Yield farming is also called liquidity mining. This DeFi use case is a more recent one, where users can lock digital assets in exchange for rewards and deliver them automatically through the smart contract. Most projects of yield farming require staking liquidity provider tokens, which are received once the user provides the liquidity.
Yield farms typically have high rewards and high risks, as any loophole in a smart contract can result in locked asset loss. Here are some things to note to earn money in yield farms, especially for beginners:
- The liquidity pool is where liquidity providers deposit funds.
- Funds are usually in Stablecoins linked to USD, like USDC, USDT, etc.
- Earning another incentive for additional funds might be for accumulating non-open market or low-volume tokens through liquidity pool rewards.
- The returns and the protocol rules depend on the amount invested in the platform.
- Different reward tokens are attainable and available by reinvesting reward tokens into another liquidity pool, allowing yield farm entrepreneurs to create complex chains.
Investing through yield farming provides a sweet amount of profit, especially if a user arrives early enough to adopt a new project. Generate token rewards by selling or reinvesting them to shoot up their value.
The world of DeFi is continuously growing and innovating and becoming a more significant part of the crypto ecosystem. The use-cases are very broad and can give a lot of benefits with high yields. It is very complex for newbies in this space and most of it is experimental. This also brings a lot of risk of losing your money. That could happen due to user mistakes, smart-contract exploits, or bad intentions by the often anonymous creators.