The implications of a decentralized world wide web are vast, considering how much of our daily processes are linked to it, and these include research, work, communication, shopping –and inadvertently, finance.
Decentralized finance or DeFi, is a field that is emerging in the world of finance within blockchain technology. We can find DeFi protocols within different chains such as Ethereum, Polygon, Polkadot, Solana, among others.
This system of finance will serve to mitigate the power that banks and other financial institutions have over money, financial goods, and financial services, giving users more power over their own finances.
You can perform most of the services that banks facilitate, such as purchase insurance, lend or borrow money, trade commodities, exchange assets, and more, and with DeFi, you can do these things much more quickly and without the need for paperwork or a third party.
Being decentralized and peer-to-peer, DeFi transactions take place directly between two individuals rather than being routed via a centralized system. It is also anonymous and available to anybody.
The sector of decentralized finance (DeFi) is expanding at a breakneck speed and has achieved a market cap of more than $140 billion in the middle of 2022. When compared to conventional finance, Defi is still an upcoming field, and considering the prospects, now would be the most opportune time to consider investing in it.
Utilizing blockchain technology to power decentralized financial apps and services, DeFi has the potential to shake up the conventional financial industry.
As a result of the astounding expansion that the DeFi field has seen over the course of the last two years, there are already DeFi options for a large number of conventional financial services, and many more are swiftly developing.
Continue reading to get an understanding of the fundamentals of DeFi, its potential, and the steps necessary to invest in it. We will discuss:
- How DeFi works
- Why DeFi is Important
- How to Invest in DeFi; and,
- Features and Advantages of DeFi
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How Does DeFi Work?
Decentralized finance protocols (DeFi) have broadened the range of investment options available in the cryptocurrency business by making it possible for unique and creative approaches to the creation of passive income.
To go a little further into how they function, we can say that DeFi systems are built on blockchain technology and operate on programmable chains like the BNB Chain and the Ethereum Network. The chains eliminate the need for a middleman by using decentralized peer-to-peer (P2P) financial infrastructures.
This makes it possible for users to lend, borrow, and provide liquidity. This results in interest rates that are higher than those offered by licensed financial institutions such as banks since there is less competition in the market.
In a centralized financial system, your money is stored with financial institutions such as banks, which are companies whose primary objective is to generate profit. There are several checkpoints of third-party operations inside the financial system.
At each point of service, these third-party service providers enable the transfer of money from one party to another and charge fees for their services.
By empowering individuals, merchants, and enterprises with the ability to execute financial transactions using developing technology, decentralized finance removes the need for middlemen in the financial system.
Peer-to-peer financial networks, which take advantage of developments in connection, software, and hardware, as well as security protocols, are all used to facilitate this.
You are able to trade, lend and borrow using software that records and validates financial acts in distributed financial databases from any location in the world as long as you have an internet connection.
Decentralized finance makes use of this technology to get rid of arbitrary finance models by making it possible for everyone, and anyone to access financial services anywhere in the world.
Why is DeFi Important?
Through the use of personal wallets and trade services geared specifically for people, DeFi apps enable users to exert a greater degree of control over their monetary holdings. Blockchain, the technology that underpins the digital currency bitcoin, serves as the founding technology for DeFi.
Blockchain makes it possible for several organizations to keep a copy of the history of transactions, which means that it isn't pinned to a centralized source.
This is significant because centralized systems and human gatekeepers may restrict the speed and complexity of transactions while also providing users with less direct control over their own money. Because it extends the usage of blockchain beyond the straightforward transfer of money and into more complicated uses in the financial sector, DeFi is unique.
The fundamental idea behind Bitcoin, which is digital currency, is taken and developed further by DeFi, which results in the creation of a full digital alternative to traditional finance but without the fees often associated with it. It is possible that this may result in more transparent financial markets.
If there were no gatekeepers to police, process, and levy fees at every stage, monetary transactions would be faster, more inexpensive, more transparent, and, most of all, more accessible.
This sets the stage for perks like making investments without being required to first accumulate a certain amount of assets and getting a loan without having to fill out any of the necessary paperwork.
Everyday investors are given the ability to access new asset classes, cut their fees, enhance their rates, and generally have greater control over the construction of their financial futures via the use of DeFi's platform.
How to Invest In DeFi
If you’re considering cashing into decentralized finances, there are a few things to consider and a few guidelines that may help you make educated DeFi decisions.
Considering how thousands of cryptocurrency projects have now flooded the DeFi market, it may be difficult to decide which investments to make for long term growth and which works best for short term runs. Examples of DeFi protocols include Aave, Uniswap, Klatyn, Pancake Swap, Celo, and Curve.
For example, generally, if a token promises low-risk, high reward, then that token is probably a pyramid scheme that has little long-term viability.
The best course of action is to invest in highly liquid DeFi assets backed by large communities of developers and users and technical studies that support the risk analysis methodologies of the assets that the protocol allows to work with.
In general, the greater the volatility of an asset and the lower its market capitalization, the higher the risk associated with investing in that asset. Below are a few steps you need to take to get started with investing in DeFi:
Get a Crypto Wallet
Your cryptocurrency wallet is the digital service, application or program where you can store your digital assets and private keys. In order to transact DeFi, you will need to open a crypto wallet. There are many crypto wallets available and in use in the DeFi space, and you can choose any wallet you prefer.
MetaMask is a very popular option and we recommend it since it gives you access not only to an exchange where you can trade DeFi coins, but also to a number of other DeFi protocols in which you can take part. This combination makes it an excellent choice. You can download it here, and find instructions on how to set it up here.
It is essential to take into consideration aspects such as accessibility and compatibility when selecting the perfect wallet. As opposed to hardware-based wallets, software-based wallets, for example, provide more access and are more practical.
Where to buy DeFi Coin
There are more than a few crypto currency exchange platforms that enable you to purchase and sell DeFi coins. Some of them, including Binance, FTX, and Crypto.com are among the most popular and trustworthy options. All these exchanges provide the best crypto security so you can rest assured about the safety of your assets.
Coinbase is an excellent option for investors who are just starting out since it features an exceptionally straightforward user experience that’s easy to become familiar with.
How to Use DeFi Platforms
It is not so hard to use DeFi platforms. In this case we are going to use an Ethereum compatible wallet as MetaMask, if the protocol you are using is not compatible with Ethereum, you should look for a wallet accepted for the protocol and compatible with the chain you are in (for example in Solana you should use phantom wallet).
Here is what you need to do to get started:
- You will need to transfer Ethereum to a wallet that supports Ether. MetaMask is the best wallet to use with DeFi programs because it offers a Google Chrome browser plug-in that enables you to simply connect to DeFi platforms via a browser extension.
- It just takes a few clicks to utilize DeFi programs after you have transferred your Ether tokens to your Ethereum wallet.
- You will be asked to link your wallet to the website of a DeFi platform as soon as you go to the website of that platform.
- After successfully connecting your wallet, you will be able to immediately manage your cryptocurrency holdings from the program's front-end interface.
Assess the Total Value Locked
The term "total value locked" (TVL) refers to the aggregate value of all assets that have been placed in decentralized finance (DeFi) protocols. These assets may earn interest, fixed income, tokens, new coins, rewards and other benefits. As a result of the fact that blockchain services are built on peer-to-peer networks, there is no centralized authority to manage, construct, or maintain the network.
As a result, investors in cryptocurrencies gain their own consideration for developing these networks from the ground up with their coins and tokens. When searching for an exceptional DeFi project, the total value locked (TVL) is an important metric to take into consideration. A key measure of how confident investors are in a project or asset and the underlying factors that drive it is a high TVL.
In general, DeFi projects that have considerable assets locked up are seen to have higher potential to go up in value, and they are also regarded as being more stable in comparison to those that have a low TVL. It is preferable to work on projects that have a steadily increasing TVL growth rate.
Evaluate the Risks
In the DeFi sector, it is not uncommon for there to be risks such as platform vulnerabilities and rug pulls. As a result of this, it is essential for investors to do an extensive background study on platform security prior to making any investments in DeFi ventures. Audits of a system's security carried out by third-party cybersecurity companies often uncover previously unknown vulnerabilities. It is strongly recommended that investors take these evaluations into consideration.
Check the FDV
Before making an investment, it is essential to take into account the FDV (Fully Diluted Valuation) of a DeFi token. The potential market valuation of a token in DeFi is referred to as FVD. This market cap is calculated by comparing the current market price to the total amount of coins that are in circulation.
When the fully diluted value is too low, it is possible that the continual growth of new tokens will outstrip demand for the token, which will lead to a reduction in the price of the token. When the FDV market is low, it might be detrimental to native tokens, which are used in DeFi investments.
Features and Advantages of DeFi
Lets's take a look at some of the most notable advantages that comes with using the features of DeFi.
Speed and Versatility
Without the need to wait for bank transfers or pay the costs that are associated with traditional banking, you are free to conduct transactions and move your assets to any location you want. Additionally, all transactions are completed in real time, and interest rate adjustments are made many times within a matter of minutes.
Inclusivity
The convenience of getting access to various financial services is one of the primary advantages offered by DeFi. Access to DeFi services is available to everyone who has a cryptocurrency wallet and an active internet connection.
Transparency
Data stored on a DeFi network cannot be altered, violated, or stolen since the network uses blockchain technology. Other users on the network are able to see and verify each and every transaction that takes place on the blockchain.
User-centric Control
DeFi platforms eliminate middleman use through the use of non-custodial cryptocurrency wallets. Users are able to keep full control over their assets at all times while transacting within the ecosystem.
Conclusion
Throughout this article, we worked to summarize important information every new investor should be armed with before stepping into the Decentralized Finance space. However, to be adequately prepared for this new field, you will need more research and Web3 education.
To help you get there, you can visit our blog to learn more about various topics concerning Web3, NFTs, the metaverse, and how they function.
