- There are many ways for anyone to make money from investing in DeFi. You could invest or trade digital assets like cryptocurrencies or non-fungible tokens (NFTs) through decentralised exchanges. Moreover, you could earn profits through crypto lending, staking, or liquidity mining.
- Multiple DeFi applications exist in today’s market, such as stablecoins, decentralised exchanges, prediction markets, and many more.
- In general, DeFi is a permissionless system because there are no centralised gatekeepers governing the entire system. Therefore, users will have full functional autonomy over their financial assets and might earn higher interest from their investments.
- There are three main steps to begin investing in DeFi – get a digital wallet, buy the appropriate cryptocurrencies for your investments, and research suitable smart contracts to take part in.
Decentralised finance, popularly known as “DeFi”, is an upcoming global alternative financial product disrupting the traditional, centralised, and large rigid financial system that most of the world has mainly been familiar with.
What is DeFi?
DeFi provides any individual owning a smartphone and has access to the internet the opportunity to make their money work for them on their own terms via financial services such as borrowing, lending, investing, and trading.
This is accomplished by DeFi removing banks, exchanges, and insurance companies as intermediaries and placing individuals in the spotlight of the peer-to-peer (P2P)-oriented financial system.
How Does DeFi Work?
DeFi got its name as this class of financial assets was built on open-source blockchains. Blockchains are decentralised databases that record the details of every transaction. Their fascinating application in DeFi involves bypassing the need for the database to be managed or governed by a central authority. The critical feature enabling this is the introduction of code-based agreements called smart contracts (also termed “protocols”), which document every transaction detail and are built on the blockchain. That way, DeFi can effectively achieve distributed consensus without needing financial institutions to issue, monitor, and control currencies. Consequently, the creation of decentralised money resulted in DeFi revolutionising how the entire financial sector operates.
Currently, DeFi is mainly tied to a well-known blockchain called Ethereum (CRYPTO: ETH) alongside all cryptocurrencies built on it. Nonetheless, many other blockchains utilise DeFi too.
The applications of DeFi are widespread, considering its capability to provide multiple blockchain-centric solutions for financial services. For example, DeFi allows people to trade cryptocurrencies as well as borrow and/or lend crypto coins. Meanwhile, fintech companies employing DeFi may expand their offerings to include insurance services, loans and savings accounts, and securities trading.
Besides that, DeFi permits any two parties to directly transfer money to a secured manager without having to include a central authority in the picture. Thus, an increasing population of people can access financial services at a reduced expense and/or be offered more attractive interest rates than those presented by financial institutions.
How To Make Money From DeFi?
There are several ways for investors to generate profits in the DeFi asset class. First, just like how one would invest or trade company shares through a brokerage account, investors can invest or trade an extraordinary range of digital assets like cryptocurrencies and non-fungible tokens (NFTs) via decentralised exchanges. Additionally, DeFi users will be able to earn an income through crypto lending, liquidity mining, and/or staking.
To dive deeper, investors can deposit their cryptocurrencies in an interest-bearing account within a crypto lending platform (e.g., a DeFi app or a crypto exchange) or choose to lend out their crypto directly. Depending on the crypto lending account, varying interest rates may be awarded, whilst others may pay a pre-set interest rate depending on the lock-up period specified. Conversely, liquidity mining is the procedure of contributing cryptocurrency assets to a liquidity pool with the aim of smoothing trades and transactions detailed within a DeFi smart contract. Participants of the liquidity mining project will be rewarded a portion of the platform’s fees or new tokens, thereby earning interest for their contributions to the liquidity pool.
Staking is a method for investors to realise interests in certain crypto investments. The process involves locking up coins followed by pledging them to a specific crypto smart contract. Similar to the interest one would earn through a conventional savings account, the interests made via staking follow a similar principle. However, the rates awarded via staking are usually significantly higher than those offered by banks. Besides that, cryptos employing a proof-of-stake consensus mechanism like Solana (SOL), Cardano (ADA), and Polkadot (DOT) depend on these staked coins to authenticate transactions. Entities that stake coins may be able to become validators of transactions, and they, in turn, are rewarded with cryptocurrencies whenever they are selected to verify a series of transactions.
Popular DeFi Applications Everyone Ought To Know
There is a wide selection of DeFi applications available to consumers in today’s market. Nevertheless, some DeFi applications that everyone should familiarise themselves with include:
Cryptocurrencies with stable values, called stablecoins, was one of the first-ever applications of DeFi. Due to its relatively lower volatility than other cryptocurrencies, stablecoins are often deemed suitable for making regular purchases.
One of the notable examples would be DAI (CRYPTO: DAI), a stablecoin issued by an open-source project on the Ethereum blockchain called MakerDAO. DAI is a coin pegged to the United States dollar and collateralised by the native Ethereum token, known as Ether. This essentially ensures DAI’s intrinsic value will remain undisturbed even if Ether’s value were to fluctuate.
Additionally, USDC (CRYPTO: USDC) is another stablecoin. However, as opposed to DAI, its collateral is centralised because the intrinsic value of these stablecoins is backed by a reserved fund of United States dollars kept within an audited bank account.
Even though cryptocurrency has a decentralised nature, various crypto exchanges like Coinbase (NASDAQ: COIN) serve as centralised platforms that link buyers with sellers.
Decentralised exchanges (DEXs) utilise smart contracts to replace the works to be done by centralised exchanges. As these smart contracts offer crypto pricing for both parties at or near the typical market prices, using a DEX permits both parties to have complete control of their own cryptocurrency holdings. Specific individuals may prefer this option instead of depositing their cryptocurrencies in a wallet held by a centralised exchange because such exchanges are often vulnerable to third-party hacking. With that, DEX users who provide liquidity through their crypto supplies may, in particular markets, earn income as a result of being rewarded a percentage of the transaction fees.
Prediction markets provide individuals with a platform to bet on specific events’ outcomes. However, like stock markets, prediction markets are usually way harder for central authorities to interfere with than standard sportsbooks.
On that note, DeFi prediction markets may present higher chances of winning as investors will be able to modify certain bet structures. Not to mention, the fees associated with the betting process are typically also lower, with market participants having the freedom to make unlimited bets on anything.
Borrowing and lending services
Borrowing and lending services are probably the most traditional function that is enabled by DeFi technology. To further elaborate, individuals owning large amounts of cryptocurrencies but wanting liquidity in other forms of currencies may borrow money by putting their cryptocurrencies up as collateral. On the other hand, individuals can also earn interest by lending their cryptocurrency deposits to borrowers, thus profiting from the value of their digital assets whilst mitigating taxable events.
In the majority of cases, the decentralised apps (dapps) facilitating these services are designed in such a way to ensure interest rates are automatically adjusted depending on the dynamic supply and demand case of cryptocurrencies.
Why Does DeFi Matter?
There are numerous reasons why people are turning to DeFi to safeguard their financial future:
With a growing number of underbanked people, DeFi offers an alternative solution to address their financial needs. Thus, the greater level of accessibility is emblematic of DeFi’s globalised nature, as transactions could occur regardless of geographical location and socioeconomic background.
Higher interest rates coupled with lower transaction fees
As DeFi bypasses the need for a financial intermediary, transaction fees are significantly reduced as any two parties can negotiate interest rates and perform the relevant transactions directly.
Greater transparency and security
Smart contracts and the complete records of all successful transactions are accessible by the general public on a blockchain. As blockchains are immutable, DeFi platform users would thereby enjoy increased transparency. What’s more, smart contracts are conferred by blockchain technology in a way that hides either party’s real-world identity. Therefore, platform participants need not worry about their privacy being at risk.
Increased functional autonomy
The 2008 financial recession revealed many of the inherent risks that centralised systems possess, as most banks and governments are significantly interconnected. On that note, the decentralised nature of DeFi smart contracts offers a unique approach to mitigating these risks because they are independent of any centralised financial institution.
Complete control over own assets
Overall, DeFi is a permissionless system, given that no gatekeepers governing the creation and participation of DeFi services actually exist. Thus, users will have complete control over their financial assets.
Not to mention, VALK is creating an all-inclusive ecosystem of decentralised tools to help you invest in DeFi. For instance, our Smart DeFi portfolio tracker, Merlin, can automatically determine the effectiveness of your investing strategies by automatically calculating the total yield and profit/loss generated from your portfolio in United States dollars (USD).
Is DeFi Secured for Investments?
Although the novelty of DeFi has generated much excitement, it is also crucial to acknowledge that unexpected adverse outcomes are a possibility. Much of this, ironically, stems from its decentralised nature. For instance, given that all deposits within conventional centralised financial institutions are backed by the Federal Deposit Insurance Corporation (FDIC), a consumer will be able to file a complaint with the Consumer Financial Protection Bureau (CFPB) if any unauthorised transactions take place. On the other hand, victims of fraudulent transactions will never be able to report fraudulent transactions, let alone recover lost money, because DeFi platforms do not offer any options to do so.
Despite the flaws in the system, it remains comforting to know that there have been innovations to address these problems. Decentralised insurance is a reasonably recent application in which individuals may pool their crypto assets as collateral for those seeking to hedge their risks against potential losses. In turn, the contributors to these crypto pools will charge premiums to the insured parties as compensation.
How Do I Invest in DeFi?
If you are impressed by the various investment opportunities that DeFi offers, a tricky question often follows suit – how could we transform those opportunities into realised gains?
- Get your wallet ready
First, you must prepare your digital wallet, which you will use to store all of your cryptocurrencies. Fortunately, there are many variants of crypto wallets for you to pick from. Still, if you happen to be curious, MetaMask is the standard go-to option by many because its users will be able to access an exchange for trading and investing purposes.
- Buy crypto coins
Similar to how you will need cash for stock investments, crypto coins are necessary if you want to participate in DeFi smart contracts. At the point of writing, the majority of smart contracts are built on Ethereum, so beginning your DeFi investment journey with Ether coins or ERC-20 tokens would be a recommended action.
- Begin researching smart contracts
Upon equipping yourself with sufficient crypto coins, the next step involves conducting in-depth research on the different smart contracts and ecosystems you could choose to participate in. Bear in mind that the general process for researching protocols begins with visiting the smart contract’s website and/or mobile app, connecting your crypto wallet with it, and following their guidelines to start lending, trading, or staking your coins for a reward.
To help you get access to every opportunity of DeFi, VALK has developed a single dashboard known as Merlin, which essentially allows you to perform analytics and report on your current and historical positions across your DeFi portfolio.
- Track your portfolio
Now that you have officially invested in DeFi, the game does not end there. In fact, this is only the beginning as monitoring your portfolio is equally crucial as selecting the right DeFi assets to invest in.
To simplify the entire process, VALK’s Smart DeFi Portfolio Tracker, Merlin, provides the most comprehensive overview of your DeFi positions to help you finetune your investment strategy.
Overall, DeFi is well-positioned to disrupt the finance industry as they have the power to make financial transactions faster, cheaper, more transparent, and most importantly, more accessible.
DeFi removes the need to place trust in human-ran intermediaries while promoting open-source collaboration. Hence, it may not be surprising when other industries start pivoting towards a decentralised future as well.
- Why invest in DeFi?
The DeFi space offers a unique class of digital assets that individuals could consider investing in to generate profits, whereby DeFi users could earn an income through lending, staking, or liquidity mining.
- Where to invest in DeFi?
There are many decentralised finance applications (dapps) for you to check out as part of investing in DeFi. Popular applications include Aave, Uniswap, Compound, Lido, Curve, and Convex.
- How to invest in DeFi crypto?
The three key steps involved to get started with investing in DeFi crypto begins with getting a crypto wallet. This is followed by purchasing the appropriate cryptocurrencies to be used as digital money for DeFi investments. Finally, conducting in-depth research into suitable smart contracts and performing the necessary steps to participate in such protocols would be the last steps to complete the entire DeFi crypto investment process.