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How To Invest In DeFi: Must-Known Investing Knowledge

Haiden Holmes

Apr 07, 2022 17:32


With the advent of blockchain technology and the decentralized finance (DeFi) revolution, the world is experiencing a sea shift in the way we understand and view money. 

DeFi is an abbreviation for digital financial exchange, which means that there are no middlemen between the consumer and the financial service provider. 

Continue reading to learn more about DeFi and how you can become involved with DeFi-related initiatives.

What is DeFi?

The term "DeFi" refers to "decentralized finance."

To appreciate why DeFi is so compelling, it's necessary first to grasp the fundamentals of Ethereum. Ethereum and Bitcoin both use decentralized blockchains, which means that no one body has control over the data kept on these blockchains.

Ethereum, on the other hand, is distinguished by its innovative contract features. At its heart, DeFi is a collection of smart contracts used to conduct financial operations such as lending and cryptocurrency trading. Whereas who may only use Bitcoin to transmit and receive data about one's Bitcoin holdings, what can use Ethereum's blockchain to store code known as smart contracts.

This "class" of digital financial goods is so-called since they are constructed on blockchain technology. Blockchains are decentralized databases that record transactions and are not centralized. As a result, they are decentralized, as are the protocols developed on top of them.

Decentralized finance, or DeFi, is synonymous with but distinct from Bitcoin (CRYPTO: BTC) and other cryptocurrencies. DeFi is an acronym for decentralized financial systems enabled by blockchain technology. DeFi is synonymous with the Ethereum (CRYPTO: ETH) blockchain and all of the cryptocurrencies created on top of it.

DeFi technology establishes decentralized money and dispenses with the need for central banks controlled by governments to issue and manage the currency. However, DeFi technology can enable a plethora of different blockchain-based financial services solutions. Fintech businesses employ DeFi technology to provide savings accounts and loans and allow stocks trading and insurance.

How DeFi operates?

DeFi is a technological solution that eliminates the need for centralized financial institutions such as banks, exchanges, and insurance firms. Distributed consensus is achieved in DeFi systems via "smart contracts" on blockchains such as Ethereum. Developers create smart contracts to conduct specified actions only when specific criteria are satisfied.

For instance, you might create a smart contract indicating that you would pay another person $500 if the Cardinals win the World Series. Once the smart contract is published to the blockchain, it is accessible and readable by anybody in the blockchain's network who cannot modify it. Often, intelligent contracts regulate decentralized applications, or "apps," which are not owned or managed by a single firm or individual. While Ethereum was the first blockchain platform to include smart contracts, they are now used on other blockchain platforms.

DeFi allows any two parties to deal safely and directly without the intervention of a third party or central authority. Consequently, many consumers now have access to financial services at lower prices or with better interest rates than conventional financial institutions provide.

The following are some of the most popular DeFi applications:


One of the initial uses of DeFi was the production of stablecoins or cryptocurrencies with stable prices. Due to their lower volatility than other cryptocurrencies, stablecoins are deemed acceptable for everyday purchases.

DAI is an example of a stablecoin (CRYPTO: DAI). The currency is tied to the US dollar and collateralized by Ether, the native Ethereum token. It is issued by MakerDAO, an open-source initiative on the Ethereum blockchain. DAI is purposefully overcollateralized by Ether, ensuring that its value remains consistent even if the value of Ether varies.

USDC (CRYPTO: USDC) is another stablecoin, except its collateral is centralized, unlike DAI. USDC stablecoins are backed by an audited bank account with a reserve of US dollars.

Decentralized exchanges

Despite bitcoin's decentralized nature, numerous cryptocurrency exchanges, such as Coinbase (NASDAQ: COIN), act as centralized platforms that link buyers and sellers of the cryptocurrency. MDEX and other decentralized exchanges (DEXs) use intelligent contracts to handle the functions of centralized exchanges, with the intelligent contracts providing pricing for each counterparty at or near market rates. By using a DEX, each participant has complete ownership of their separate cryptocurrency holdings instead of putting them in a centralized exchange's wallet, which may be exposed to hacking.

DEX users that provide liquidity by contributing cryptocurrency might make revenue by receiving a percentage of transaction fees in some marketplaces.

Market forecasting

The prediction markets allow individuals to wager on the outcomes of certain events. By altering the structure of bets, DeFi prediction markets may increase their chances of winning. Additionally, related expenses are reduced, and market players may wager on anything indefinitely. Compared to traditional sportsbooks, prediction markets are significantly more difficult for central authorities to shut down.

Beyond improved access to gambling, DeFi prediction markets may give a benefit. Stock market forecasts weighted by the magnitude of the bets they are based on are often very accurate.

Lending and borrowing

Among the most typical tasks offered by DeFi, Borrowing and lending services are accessible to cryptocurrency users. Individuals who have a significant quantity of cryptocurrency yet want liquidity in other currencies might borrow money using their cryptocurrency holdings as collateral. Individuals may lend their cryptocurrency deposits to borrowers in exchange for interest, earning from their holdings' prices without triggering taxable events. The dapps that support this decentralized borrowing and lending are constructed so that interest rates alter automatically in response to changes in the cryptocurrency's supply and demand.

Why is DeFi significant?

Without these gatekeepers regulating, processing, and collecting fees at every stage, financial transactions become more efficient, inexpensive, transparent, and, most importantly, accessible.

Consider being able to invest without meeting a minimum asset requirement. Consider taking out a loan without completing any paperwork.

DeFi enables average investors to access new asset classes, lower their fees, enhance their rates, and generally exert more influence over their financial destiny.

The Advantages of Defi

Regardless of the objective, employing a DeFi platform in place of conventional financial institutions might bestow various advantages.

  • Accessibility: While some individuals cannot create bank accounts or get loans, everyone with an internet connection can use a DeFi platform. Due to this high accessibility, DeFi transactions are not geographically restricted.

  • Low costs and high-interest rates: DeFi permits direct transactions between two parties. Without a middleman, transaction expenses are significantly reduced, and parties may negotiate interest rates directly. Individuals who lend money over DeFi networks generally earn higher interest rates than conventional financial institutions.

  • Increased openness and security: All smart contracts published on a blockchain and all associated transaction records are publicly accessible. Blockchains are immutable, which means who cannot alter them in any way. While users of the DeFi platform benefit from the transparency and security provided by blockchain technology, smart contracts are performed in a manner that protects the network's members' anonymity. The transaction data that is publicly accessible does not expose your true identity.

  • Functional independence: DeFi systems are not dependent on anyone financial institution. The 2008 financial meltdown demonstrates the massive interdependence of the majority of institutions and governments and the inherent dangers of centralized systems. Individual financial institutions that hold your money may encounter difficulties or corruption or become excessively leveraged and declare bankruptcy. Much of this danger is mitigated by the decentralized nature of DeFi protocols.

How to Use DeFi Effectively?

Direct interaction with DeFi programs is the most effective approach to learning about this young and rapidly developing business. Additionally, users of DeFi build interest in their cryptocurrency. Interest-bearing platforms provide an excellent chance to increase your cryptocurrency holdings without spending more funds on cryptocurrency continually.

Utilizing DeFi software is simpler than you would believe. There is no need to register an account, get approval, or verify your identity. Rather than that, you'll need to transmit Ethereum to an Ethereum wallet to begin. MetaMask is the ideal wallet to use with DeFi programs since it has a Google Chrome extension that enables you to connect to DeFi platforms directly from your browser.

After transferring your Ether tokens to your Ethereum wallet, you may start using DeFi apps in seconds. After visiting the website of a DeFi platform, you'll be requested to link your wallet. After connecting your wallet, you may manage your crypto directly via the program's front-end interface.

Is DeFi safe?

Due to the novelty of DeFi technology, unexpected negative results may arise. New businesses that employ DeFi technology may fail (start-up failure is quite prevalent), and programming flaws may generate lucrative possibilities for hackers. Investing in or holding funds in a failed DeFi project may completely lose your cash.

The Federal Deposit Insurance Corporation (FDIC) covers deposits at conventional centralized financial institutions, but DeFi platforms often do not provide any mechanism for recovering stolen funds. While a customer may register a complaint with the Consumer Financial Protection Bureau (CFPB) if a conventional financial transaction goes wrong, there is no such remedy if you become a victim of a fraudulent DeFi transaction.

Interestingly, a new sort of DeFi application is emerging to overcome these shortcomings. Decentralized insurance is being given to customers who seek to protect themselves against losses caused by other smart contracts. It is produced by individuals pooling their cryptocurrency as collateral, and individuals who participate in cryptocurrency pools charge premiums to those covered collectively.

DeFi vs. TraditionalFi

Since certain financial processes on Ethereum are conducted by code, a large portion of the overhead associated with conventional finance (TradFi) is eliminated. DeFi does away with the necessity for a real bank facility, personnel, and cumbersome bank transactions. Aave, one of the main DeFi systems, manages moreover $15 billion in assets with a staff of less than a dozen.

Due to the fact that a large portion of the overhead expenses involved with lending and trading are eliminated via code, customers gain far more through DeFi than TradFi. Savings account interest rates on DeFi products are nearly ten times higher than those offered by conventional banks, and you avoid exposure to unpredictable crypto markets entirely by utilizing stablecoins.

How to invest in DeFi

There are several opportunities to earn money at DeFi. Rather than settling on one strategy and forgetting about the others, we advocate experimenting with all three. In this manner, you can determine for yourself if a certain method is appropriate for your psychology and personality type.

1. DeFi asset trading

Trading or investing in DeFi assets is the most profitable way in this market. Users may invest in long- or short-term holdings on non-custodial decentralized exchanges such as Uniswap, SushiSwap, and Bancor.

The majority of investors invest by purchasing cheap and selling high when an opportunity presents itself and market circumstances are favorable. Due to their small market capitalization, DeFi assets sometimes quadruple or treble in value over a short period of time. As a result, they are ideal for dramatically increasing the size of your portfolio.

Other users desire to be among the first to participate in a newly announced initiative. Those who understand how smart contracts function and are capable of quickly determining if a project is legitimate or not merely by reading these contracts may earn a career by distinguishing between legitimate and fraudulent enterprises. The payoff is far greater in this situation since investors pay presale prices for tokens that will climb five to tenfold after they are published on Uniswap.

Finally, but certainly not least, we have a group of day traders that are continually buying and selling tokens at the tiniest profit margins possible. A 20% price rise is sufficient for these individuals since they are attempting to reproduce their accomplishment at least many times during the day.

As you can see, trading DeFi assets is far more complicated than purchasing and selling a token. There are several trading styles available, and it is up to you to choose which one is the greatest fit for you.

2. High-yield farming

Are you a subscriber to passive income? Nothing beats making money without having to do anything. The simplest method to have fun in the universe of DeFi is via yield farming.

Yield farmers earn a livelihood by supplying liquidity to a decentralized exchange in the form of cryptocurrencies. The DEX leverages this liquidity to fulfill orders placed by fee-paying token swappers. Yield growers get a percentage of these fees according to their contribution.

A yield farmer's objective is to join the liquidity pool with the greatest yield. They often switch between liquidity protocols in search of the best prices. While you may like to enhance your profits by pursuing the finest tactics, money may still be produced just by placing your assets in a Uniswap LP and forgetting about them.

3. Profit from a lending procedure by earning interest

Lending protocols are decentralized lending networks that connect borrowers and depositors. While one group provides liquidity in order to earn interest, the other group obtains liquidity via a loan and pays interest.

Aave and other lending platforms provide both variable and fixed interest rates. Variable interest rates fluctuate in response to the demand for the asset. Fixed interest rates, on the other hand, remain constant regardless of market circumstances.

Here's a tip: in a bull market, you may optimize your profits by using variable interest rates on Aave. Once the market enters a negative period, go to fixed interest rates to steady your income.

The Risks Associated with Investing in DeFi

Due to the fact that DeFi is a relatively new technology, investors have a lot of questions before investing immediately. Numerous new businesses, particularly start-ups, are emerging to provide DeFi services, raising worries about their effectiveness.

Rather than relying on central policies and human decision-making, DeFi depends on the power of underlying programs or smart contracts. While this is one of DeFi's greatest features, programming mistakes sometimes occur, creating gaps for attackers. Fortunately, DeFi insurances like Nexus Mutual are growing in popularity, providing safety for tokens and transactions.

Taxation in crypto is already commonly regarded as difficult and dynamic. The investor spends a significant amount of effort monitoring, consolidating, reporting, and complying with proper taxes laws. DeFi seems to be exacerbating this difficulty at the moment since tax treatment varies by application.

Rug pull scams are prevalent in DeFi, which is understandable given the technology's novelty. To avoid such frauds, it is always advisable to adhere to DeFi tokens with strong liquidity and a substantial number of cryptocurrencies staked on the network.

When you come across a token that offers high yields for nothing, also known as frictionless yield farming, you should be able to discern the token's pyramid scheme and lack of long-term viability.

At the moment, DeFi apps are only available to a select set of persons who understand the technology and how to utilize it. Due to the smaller user population, documentation is less extensive than with standard financial services. Asset custodians who are readily accessible are not yet on the horizon. The silver lining is that various breakthroughs in the area of decentralized insurance are emerging gradually.

Individuals are pooling their cryptocurrencies to provide collateral for those seeking protection from losses incurred by other smart contracts. Premiums are collected from people who are insured by contributing individuals.


The DeFi cryptocurrency market is very volatile, which means that large profits and losses are always possible. The DeFi market capitalization decreased by more than 41% in less than two months, from $88.46 billion on 12th May 2021 to $51.47 billion on 1st July 2021. As confidence and understanding in DeFi grow, and smart contracts gain traction with a growing number of investors, DeFi may soon become the financial finance's future.