DeFi, Decentralized Finance has been one of the hottest topics in the cryptocurrency space over the past year and does not show any signs of slowing anytime soon.
Here we will take a look at what exactly is DeFi, what are the implications as DeFi is adopted, and ways available to earn in the DeFi space. DeFi is an ecosystem of financial applications built on top of blockchain technology without the control of a central entity like a bank or governing body.
Decentralized finance tools will allow you to lend and earn a return, and borrow with collateral, without the need for any intermediary. Every form of centralized finance is built in boxes that exclude those who are outside of the box. These limitations can be in many forms, most commonly lack of income and what side of a border that someone was born on. DeFi uses decentralization and distributed systems that allow you to transfer value without the need of intermediaries.
Besides decentralization, there are three other aspects to DeFi that are important and all tie into the decentralization mantra.
OPEN: As borders were just mentioned, having a protocol that restricts no one, as long as they have a wallet and an internet connection, is crucial for DeFi.
TRANSPARENT: Transparency allows anyone to be able to verify the applications and protocols work. In DeFi, codes are open source, and in many cases can be copied and built upon by many other developers. This can definitely lead to a better ecosystem as the best and brightest technologies will continue to be built upon and adapted as needed.
NON-CUSTODIAL: The user that is interacting with the distributed network are the only ones who hold the keys to their wallets and control their funds. This can help to reduce the risk of losing money and also to prevent censorship. This also means that the user’s responsibilities are magnified as you are ultimately responsible for your security.
While DeFi has several functions available, the two most widely used that we will explain next are participating in liquidity pools and yield farming, which can be considered an added task to participating in liquidity pools. In centralized exchanges, entities referred to as market makers provide liquidity by agreeing to fill market sell orders that do not have a matching buy order, and vice versa.
This allows the markets to continue to trade. To solve this problem in a decentralized environment, this action is automatically managed by smart contracts and liquidity provided by users. Users deposit an equal number of the token providing liquid to, and the native coin to the chain, for instance Eth on Ethereum chain and BNB on Binance Smart Chain. The depositor of the liquidity can then earn a portion of transaction fees.
To move on the yield farming, there are some protocols that when you provide liquidity or just basically lend your tokens, but also earn a yield of another token. An investor deposits digital assets in a lending protocol to earn interest or fees in exchange for providing liquidity. As an additional incentive, users typically also receive extra yield in the form of the protocol’s governance token. Some may even compound the yield by lending the governance token on another protocol.
Participating in liquidity pools or yield farming can be a way to earn passive income, but they also come with their share of risks. In the past, exploits in smart contracts have caused many to lose what they had locked in the liquidity pool. Also, the asset you are providing liquidity for can drop drastically in price, and negate any gains you may have made from lending. It is still early in the space so be very careful to research the ones you put money in. As always, never risk more than you can afford to lose. Safety measures to prevent these types of losses are constantly being developed as this is a rapidly expanding space. .
Ethereum has been the network of choice for DeFi projects so far due to the capabilities already within the network, but other blockchains are starting to heat up. Over the last year, Uniswap, a decentralized exchange, grew rapidly to now facilitating over $1 billion dollars in transaction volume daily and now many spin-offs and copies of Uniswap have launched.
To learn more about how to utilize Uniswap, check out one of our past blogs. Ethereum’s decentralized applications built to facilitate DeFi, currently have over $20 billion in assets locked into their protocols. Through all of this growth and adoption, network congestion due to scalability issues have plagued the Ethereum network. As network congestion increases, the gas fees also increase. Gas fees are the network fees paid to the miners for verifying the transactions. Gas is a unit of measurement for the amount of computational power required to execute certain operations on the Ethereum blockchain.
For smaller transactions, at peak network congestions, many could see the gas fee as high if not higher than the amount of value being transferred. Ethereum has a roadmap to make the network much more efficient with the rollout of Eth2.0, but full rollout of this could be at least 1-2 years away. To learn more abou the Eth2.0 rollout, check out our past blog.
Through this, the biggest rise in DeFi progress has been happening on the Binance Smart Chain. I recently had two identical transactions, and the one on the Ethereum network had a gas fee value of $80, while the fee on the Binance Smart Chain(BSC) was $1.40 value. The network congestion is less impactful on the Binance Smart Chain, but there is also less of a level of decentralization, and even have some countries’ IP addresses blocked to not allow them to use the platform.
Several other chains beginning to have DeFi infrastructure built on them are Polkadot, Tezos, and Cardano. Even Stellar is exploring ways to incorporate DeFi in the future, which I found out recently while interviewing Cem Arcane of the Stellar Foundation, although no definitive dates were discussed. All have a ways to go, but it will be an interesting race to watch and see who brings the most adoption of the masses in terms of DeFi.
Newscrypto.io is positioning itself to potentially capitalize on the DeFi growth, but rolling out a crosschain swap for the NWC token to allow it to potentially be used in multiple DeFi protocols, bringing much more use case and adoption to its token. In essence, you can swap the original NWC token for an NWC token on the Ethereum blockchain and also on the Binance Smart Chain. To learn more about how to execute the swap, here is a guide on how to do it.
While DeFi still has a ways to go for mainstream adoption, like any other emerging technology, learning about it early and educating yourself on it will allow you to position yourself to benefit financially by capitalizing on it.