In this article, we look at DeFi, or blockchain-based decentralized finance. Why is it important? It is almost certain that the revolution in global finance will be based on DeFi, involving the automation and reduction of costs of traditional financial operations.
What is DeFi?
DeFi (Decentralized Finance) is a category of open financial services based on smart contracts. Each contracting party, creator, recipient and host can find all sorts of benefits from using this new system.
These include a possibility of immediate earnings (market making), lower costs (compared to traditional finance) or the opportunity to participate in the development of the new technology and benefit from the increase in the value of ventures.
What makes a token belong to DeFi?
Generally, it is difficult to assign specific factors that will characterize the DeFi category. Decentralization means they have to be distributed. However, a degree of management concentrated in one hand is often beneficial. The financial part may also be questionable. Is it just about investments or is an insurance also DeFi? What about tokenization of various types of business? So let’s examine the factors that Messari identified.
- Application in finance: markets, exchanges, etc.
- Permissionless: open source without permission.
- Pseudonymity: no need to reveal your identity.
- Non-custodial: without having to lose control over the funds.
- Decentralized management: Development and administration decisions are not concentrated in a small number of hands.
According to this classification, projects such as Chainlink, Ethereum or Binance Coin will not be classified as DeFi.
Why are DeFi important?
DeFi have the potential to replace ineffective ways of conducting traditional finance. If the markets are trusted, many of the usual solutions such as insurance, asset management and banks will be replaced by automated systems and blockchain-based protocols.
In developed markets, DeFi will be another innovative option that customers will be able to choose in order to save or gain additional financial liquidity. In emerging markets, it may be important to provide a vehicle to stabilize prices and ensure that millions of people have access to cheap financial services on a smartphone.
Liquidity mining, or earning money on DeFi
In essence, liquidity mining is about enabling asset holders to earn money just by having cryptocurrencies. The risk for the holders is minimal, because most often the tokens do not leave the secret private key, but are temporarily placed in a smart contract. The reward for providing liquidity may be the same token or a different token for the protocol used, for example Compound (COMP) or Uniswap (UNI).
Stable Coins allow you to automate your finances
The growing importance and capitalization of stable coins allowed for the stabilization of the market and the development of DeFi. Interestingly, users, having a choice of priorities: scalability or decentralization (and trustlessness), selected scalability.
As a result, the vast majority of stable coins depend on central management. According to Messari, of the $ 12billion in stablecoins, only ~2% is non-custodial. You can also see very clearly how much the role of stable cryptocurrencies has increased compared to the capitalization of BTC and ETH.
What are DeFi built on? Mostly on Ethereum, although smaller projects like Cosmos are trying to take over some of the market. The DeFi revolution caused the transaction costs in the ETH network to go up. This showed how badly there is a need to modify existing algorithms and networks to improve the scalability of the ecosystem.
Ethereum has projects in all DeFi categories.
Stablecoins: USDT, DAI, USDC
Credit Markets: Maker, Compound, Aave
Decentralized exchanges and automatic market makers: Uniswap, 0x, Kyber
DAO: Aragon, DAOStack, Moloch
One of the few competitors is Cosmos, where Kava, Terra, THOR, Band operate.
Reviewing the available financial instruments in decentralized finance is a challenge as industry changes are instantaneous. But let’s try to look at the most important projects one by one.
How to invest on Uniswap
Uniswap is a decentralized token exchange that functions as an automatic market maker. A market maker is someone who provides liquidity to the market. There is a UNI token on the market, issued by Uniswap in September 2020.
Uniswap has become a major DeFi exchange with over $3 billion deposited. This is a rapid development because three years ago it was a small project sponsored by a grant from the Ethereum Foundation. The stock exchange has already paid out over $60 million to over 50,000 market makers. Compared to trading other exchanges, Uniswap would be in 4th place, behind the most popular Binance, Huobi and OKex.
The most important event in the history of Uniswap was an airdrop of hundreds of millions of dollars in UNI token. All early users of the exchange got 400 UNI or more, in proportion to the liquidity provided earlier.
How does Uniswap work?
Liquidity providers block a pair of tokens in a smart contract (for example, ETH and DAI), so that market participants who need liquidity can use it. As a reward, they receive usage fees.
How does it look in practice? You should prepare equal token values, e.g. $100 in ETH (0.25 ETH) and $100 in DAI (100 DAI). The market sets the ratio in which the two currencies are currently in relation to each other (curve). After blocking in the contract, the value curve of both tokens from the pair will determine the value in the blocked contract.
What is automatic market making?
Uniswap, when blocking funds in a contract, operates with proportions depending on the equation: token x * token y = k. K is constant. Uniswap changes the value of X and Y proportionally so that k remains the same. Due to the fact that the value of X and Y depends on temporary demand and supply, the exchange is counting on arbitrators to bring the price back to market equilibrium.
What is an Impermanent Loss?
It is worth paying attention to the phenomenon of “impermanent loss”, which results from the variable value of tokens. You may find that a relative decrease in the value of one of the cryptocurrencies means less cryptocurrency at the close of the contract. This is a real issue that should be addressed by the investor.
If one of the tokens in a pair suddenly increases in price, the second token blocked in the contract will be instantly redeemed by arbitrators. The sponsor of the loss will be … Uniswap, the market maker. Although the change will not be felt now, you will receive correspondingly less if the contract is closed.
How to earn on Uniswap?
You can earn money by providing liquidity on Uniswap. The interest rate range depends on the cryptocurrency pair to which we provide liquidity.
The most popular pairs are BTC-ETH (Bitcoin in the form of Wrapped BTC), ETH-USDT, USDC-ETH and ETH-DAI. A complete list of pairs with their expected return can be found on uniswap.info.
How much can you earn with Uniswap? Some cryptocurrency pairs have rates of return above 100% per annum. These are the less frequently used markets where liquidity is currently sought.
How to add liquidity to Uniswap?
Adding liquidity to Uniswap is just a few clicks away from the Uniswap application page and the MetaMask wallet. It is worth remembering that participation in the market requires at least two transactions that can cost even several dollars. This should be taken into account in calculating future profits.
Make sure you have funds in both cryptocurrencies in the pair.
Choose a cryptocurrency pair, Choose a token. Adding a token requires confirmation in MetaMask and payment in ETH.
Add liquidity in the selected token. Take into account the amount of the transaction fee. You can reduce it if you do not care about the time to confirm the transaction and it may be longer.
To change the amount of the transaction fee, click “EDIT” above the amount of the fees. You will be on the MetaMask subpage, where you can choose the proposed fees or set the amount of GAS yourself in the “Advanced” tab.
After clicking Confirm in MetaMask, the transaction will be initiated and the time of its execution depends on the amount of Gas Fee.
Once the contract is fulfilled, you start earning money by providing liquidity on Uniswap.
Liquidity mining on Uniswap
An additional earning option is depositing ETH DAI and ETH USDT pairs. Thanks to this, we can use the liquidity mining mechanism and receive UNI tokens.
To do this, you need to sign a transaction (for free) and confirm the shipment of tokens to the smart contract (standard transaction fee in the ETH network).
What can be done with UNI tokens? If you believe the value of the Uniswap token will increase, you can just hold them.
If, on the other hand, you want to cash them immediately, the fastest was the Binance exchange, where UNI token trading has already been launched. On the day the tokens were launched, they were worth around $3, so the minimum package of tokens distributed by Uniswap was worth over… $ 1,200! The highest price UNI has reached was over $7!
How to invest in Compound?
Compound is a flagship project in the sector of providing liquidity to the market, operating at compound.finance. It is an algorithmic, stand-alone interest rate protocol that allows users and applications to earn money by sharing or borrowing tokens from the Ethereum chain.
The project, thanks to liquidity pools, made possible borrowing assets without having to find the other party to the transaction directly. To achieve this, the investor adds his cryptocurrencies or tokens to the pool and receives shares in return, called cTokens.
Users can borrow multiple cryptocurrencies at interest, the most profitable ones at the time of writing, USDT, USDC, and DAI.
The interest rate is determined by algorithms and depends on the state of the market, i.e. demand and supply. There is no need to specify a specific investment period, you can even invest for the mining period of 1 ETH block.
Interestingly, payouts of the COMP token are received by both stackers, that is, adding liquidity to the system, and borrowers. The Compound (COMP) token was issued in the amount of 10,000,000 (ten millions).
Details about the token, how to calculate the interest rate can be found, for example, in this instruction.
Popular wallets, including Metamask, allow access to the Compound native interface.
Who controls Compound?
Compound is managed in a decentralized manner by COMP token holders and their delegates who have voting rights. Addresses that hold more than 100k COMP are eligible for submitting applications.
The storage of the COMP tokens only gives a voting right to decide about the future of the protocol.
What are the risks of COMP at first sight? Out of 10M tokens that can be placed on the market, less than 35% is in circulation. This means that future emissions or the introduction of COMP to the market may cause the price to fall.
Note, GAS costs a lot of interaction on the site. At a time when the rates are high, simply redirecting the tokens to investments can cost even several dollars!
How to earn on Compound?
Compound is a seemingly complicated financial platform. We start by depositing funds in the pool to receive a share of the interest. Then we can earn a COMP token, which is given to those who provide liquidity and borrow (!). We can also borrow cryptocurrencies using our deposited funds as collateral.
How to use the DeFi Compound platform?
The most popular cryptocurrencies such as DAI, Ethereum, WBTC (Wrapped BTC), Tether USDT or USDC are available for investment. You can earn the most on volatile cryptocurrencies. The rate of return on liquidity in the most popular DAI or dollar-denominated stable coins is 2-3% per year.
On the compound.finance protocol page, select the application (App) and connect to a popular portfolio, eg MetaMask. The panel shows the balance of our address, deposited funds and interest that we can count on when investing specific cryptocurrencies.
If you have a deposit, you can see how much you are able to borrow against your collateral. There are risks involved in using this option. If our investment predictions are wrong or the token we borrow increases in value, we risk liquidating the position. This means that the virtual loss resulting from exchange rate movements will become a real loss in the portfolio.
There are two steps to investing. First of all, we choose a token from the list, for example a popular DAI (click the token so that a window with further steps will pop up). In order to make a deposit, click Enable and confirm the transaction in MetaMask. It is necessary to check the amount of the transaction fee and the offered rate of return. They need to be positive, which is not always possible, when fees are sky high.
The next step is to deposit a token or cryptocurrency to the protocol. This has been announced by us in the previous step. We confirm the deposit once again in MetaMask, checking the cost of the transaction.
After confirming the transaction (you can check the progress, e.g. on Etherscan), you can see on the Compound dashboard the amount of the deposited token and interest practically in real time.
In the Vote tab, we can see how much we received the token managing the COMP protocol. If you earn enough tokens, you can transfer it to your own address using the Collect button (the transaction costs!).
How to invest on Aave?
Project Aave, formerly Lend, offers quick loans. It happens usually without even checking the borrower and his creditworthiness, from which the company charges 0.3% commission. Aave benefited from the development of the Compound platform, which was used in its own liquidity mining mechanisms.
Instead of examining the capital and nature of the borrower as in traditional banking, Lend allows you to grant loans to anyone who secures the appropriate collateral in a smart contract.
On the other hand, cryptocurrency holders can add to the pool that the borrowers use and earn. More than $1 billion has been deposited in Lend in tokens and cryptocurrencies.
Aave tries to position itself as an improved Compound. At first glance, the platforms have similar functionality. You can deposit cryptocurrencies and earn interest, as well as treat them as collateral and start the loan carousel.
Aave, however, has a lot of additional advantages, which we’ll look at in more detail. The most important innovations are:
- investments with a fixed rate of return,
- Safety Module safety fund,
- flash loans, i.e. quick borrowing,
- private markets,
- optimization of Gas charges,
- an increased lien rate that can be used for loans (compared to Compound).
It is a solid set of useful functionalities and a successful attempt to build an advantage over the competition. It is also reflected in the amount of deposits in the protocol, which is constantly increasing.
How to use Aave
We connect to the Aave application using the MetaMask wallet. As with other sites, you must connect your wallet to the Aave app. Then select Deposit, and select the desired deposit amount from the screen. Then confirm the transaction, checking the fee, of course.
The deposit interface is the best realized panel of all DeFi. The clearly shown necessity to make two transactions definitely makes it easier for novice users to use the website.
Along with posting a deposit, Aave creates aToken (the equivalent of the deposited token with “a” at the beginning) which entitles you to receive interest. The main page lists the protocol supported tokens, along with the current rate of return.
Aave Token (LEND)
Is it worth investing in an Aave token? As with the competition, the token was designed to manage the protocol. Recently, it has also undergone a rebranding that involved a 100:1 reverse split of old LEND tokens.
The way to add value to your project is worth analyzing, which is to burn 80% of the fees charged on the Aave token. The goal is to reduce its supply and ultimately lead to an increase in its value. More information on staking can be found on the protocol page.
How to invest on yearn.finance?
Yearn.finance is an aggregator of various DeFi protocols. Investors looking for the best returns can use yearn to automate earning on popular DeFi platforms such as Compound, Aave, dYdX and allocate funds where interest rates are the most favorable.
In practice, by sending DAI to the yearn.finance smart contract, for example, you use an automated process to identify and deposit funds in the most profitable pool.
There is a YFI token in the project, which is used to manage the platform. Additionally, the protocol charges a 5% commission and a 0.5% withdrawal fee. Due to the small number of issued YFI tokens, which is only tens of thousands, the holders have an influence on where the funds earned by the platform are directed.
yVaults are capital provider markets that are allocated according to your chosen investment strategy, supported by vending machines. Thanks to this solution, those looking for market returns automatically search for the best rates of return on the market. In addition, the platform allows you to optimize gas fees.
The Binance cryptocurrency exchange immediately after launching allowed trading with the YFI token and built a large position of around 15% of YFI. If you’d like to learn more, check out YFI’s history and yearn.finance technology details.
Is yearn.finance ahead of competition?
The development is impressively fast. Yearn has amassed over a billion dollars under management. Additionally, it is expanding its operations to other important sectors, such as the decentralized exchange, loans, stable coin and even insurance.
On the one hand, StableCredit seems to have a functionality that is analogous to that of other exchanges, such as Uniswap. The simplification is that instead of two sides of the liquidity pool, you only need to fund one side. As a result, the investor blocks the asset in the smart contract, receives a credit line, thanks to which he can borrow up to 75% of the collateral. The loan is made in a new stable coin, StableCredit. The advantage of the project is that it does not artificially limit supply, thanks to which the increased demand for StableCredit will allow it to move to the league where USDT is currently dominating.
How to use yearn.finance?
To use the automatic highest interest rate search system, go to Yearn Vaults and deposit stable coins or their synthetic equivalents from various protocols, Ethereum or Chainlink.
How does Yearn Vaults work?
After expanding individual pools, you can check which strategy is currently active and what rate of return can be expected, based on the past data. There are also Deposit and Withdraw buttons if you already have an open position.
You can also get positive returns by using Yearn Earn. Similarly to the competition, just deposit assets, i.e. the most popular cryptocurrencies and stable coins to provide liquidity to the market and get paid for doing so.
The developing ecosystem enable depositors to benefit from the advantages of automatically finding the highest interest rate available. Investor funds are shuffled between exchanges, mainly Aave, dxdy and Compound, in search of higher returns.
Is it worth investing in a YFI token?
The YFI token is designed to manage the protocol, and its holders have the option to vote on changes. It is available for purchase on the Binance exchange. Due to the fact that there are only 30,000 of them, the price of YFI even exceeded several dozen dollars for 1 token.
How to invest on Curve.fi?
This is another project from the automated market maker category. Its potential lies in operating within stable coins. As a result, investors gained access to a market with small price slips, managed by algorithms with low fees.
This platform’s liquidity pools work with many DeFi, mainly on Compound and yearn. The most popular pools are COMP, PAX, Y, BUSD, sUSD, ren and sBTC. The native CRV token is ultimately intended for management.
Curve is a protocol that focuses on the stable coin market. Curve.Fi has a not very friendly interface, reminiscent of the old DOS screen (you can see that it was designed by an engineer detached from reality). However, it’s important not to get discouraged.
Often there is an imbalance in the liquidity pool, which consists of, for example, four cryptocurrencies: DAI, USDC, USDT, TUSD. By depositing the token that is missing to restore the balance, we get “a bonus”. It is therefore enough to make a deposit at the right moment to earn from the very beginning thanks to arbitrage.
Then, the investor’s deposit is divided into individual components of the pool and made available for a fee. This way, the deposited cryptocurrencies earn trading fees and lending fees. Additional incentives are the surcharges in some protocols, such as Synthetix or Ren.
How to earn on Curve.fi?
First, you need to have cryptocurrencies that you want to deposit in a friendly wallet, such as MetaMask. The wallet connects to the Curve page.
We have a lot of useful information on the protocol page. Connecting the wallet allows you to view transactions. The estimated cost of the transaction will allow you to assess whether this is a good time to fund the pool. The reserves of particular Curve currencies will show whether we can count on a good rate to start the investment.
Choose the pool you would like to deposit your funds to. Confirm selected token, don’t forget to check Ethereum gas fees. After signing the transaction you are going to get your share of the pool.
What is the role of the CRV token?
The CRV token has three main roles: voting participation in the protocol management process, staking and boosting. To participate, you must deposit a CRV (vote lock) and purchase a veCRV. Check the instructions for using the CRV.
However, the most important advantage of CRV seems to be Boosting, thanks to which you can increase your earnings up to 2.5x. Depositing CRV tokens allows you to participate in DAO and increase your share in the profit distribution. See the Boosting rewards CRV manual. When making a transaction, take into account the amount of transaction fees.
It is also worth remembering that the CRV deposit period is the most advantageous when choosing a period of up to 4 years! This means placing a lot of trust in the development of the project.
Is it worth investing through the Curve protocol?
After the initial boom in deposits, it’s time for a summary. Investors who received double-digit rates of return at the beginning of the platform’s activity currently receive from 1% to 3%.
Investing in a CRV token makes sense when we intend to actively participate in the Curve.Fi ecosystem and boost our investments. The possibility of increasing the rate of return by 2.5x means that investing without this booster does not make much sense on this platform.
The future of the DeFi and cryptocurrency market
What revolution is DeFi bringing with it? It allows investors to use capital more efficiently. It offers a new approach to traditional financial services, including borrowing and insurance. It consolidates services and ecosystems around working solutions. It carries great prospects for this fresh industry.
What is the future of the DeFi market? The adoption threshold has been exceeded. The management panels for individual projects are relatively beginner-friendly. DeFi’s step-by-step instructions and guides are clear and legible. Smart contracts operate as designed and intended in the intentions of their creators. This is a very good sign for the future.