The cryptocurrency industry is constantly evolving. One of the new promising applications of blockchain tokens is decentralized finance (DeFi).
DeFi (decentralized finance, decentralized finance) is a set of services and applications developed using blockchain, cryptocurrencies/tokens and smart contracts. Services are integrated into a single network, offering users systems that are usually provided by banks and other financial institutions.
In simple words, this is an alternative banking sector, the services of which can be used by people who do not want / are not able to deal with traditional financial institutions.
We could compare the current state of the DeFi crypto construction with the Internet boom of the 90s, when the Internet, on the one hand, already promised amazing opportunities, a huge amount of innovation and explosive growth potential for investors, and on the other hand, many bubbles are waiting in the wings. , and burst in the late 90s. In much the same way, DeFi protocols promise to radically change the financial world, just as the early Internet transformed a huge number of industries, from travel to retail and everything in between.
The modern world runs on funds: be it fiat money like euros or dollars, or cryptocurrencies, the basic use case is the same. It underlies our daily existence. Any revolution here is something that will affect everyone sooner or later. Currently, DeFi is still in its infancy, however, the way things are shaping up, DeFi could very quickly make its way into the realm of traditional finance.
In this article, we'll look at the differences between investing in decentralized finance (DeFi) tokens such as UNI (UNISWAP's decentralized exchange control token) or AAVE (the platform token of the same name that powers the decentralized protocol), or through DeFi products such as UNISWAP ( a non-custodial crypto exchange that uses the decentralized protocol of the same name) or AAVE (a decentralized financial platform where customers can borrow digital assets or lend coins without intermediaries). We will also look at how to actively invest in DeFi or use DeFi to generate passive income. Different approaches have their own advantages and disadvantages depending on the desired outcome and personal risk appetite.
Decentralized finance is a new way of looking at how we bank, borrow, lend, speculate and even buy insurance. Usually, when we provide these financial systems , we have to look for banks or financial institutions to offer opportunities, but by decentralizing (removing intermediaries) them, we leave it up to the blockchain and open source smart contracts available for verification. You don't really know how your bank works, but you can be pretty sure that the smart contract will do what the code says.
Besides the fact that these traditional financial services are simply decentralized and therefore more reliable and efficient, there is also the potential for new ways to make your funds work for you.
The two main ways to invest in DeFi.
Direct investment in DeFi tokens such as UNI or AAVE.
Investing through DeFi products, that is, earning by depositing your crypto assets in UNISWAP or AAVE liquidity pools.
Investing in DeFi assets such as UNI or AAVE means that you buy the token itself, which is a tradable digital asset, and make or lose money based on its price fluctuations. This is different from financing through the DeFi protocol, where you use the DeFi platform to earn funds by earning interest or other types of rewards. Roughly speaking, investing in tokens is buying shares in your bank. And financing through the DeFi protocol is making a profitable deposit in your bank.
Let's start by looking at how to invest in popular DeFi projects by buying UNI or AAVE tokens. Of course there are many others, but we will use UNI and AAVE as examples.
AAVE is a decentralized credit pool system where, on the one hand, interest-bearing deposits can be made and, on the other hand, borrowers can use liquidity pools in exchange for a fixed or variable interest rate. AAVE began operations in 2017 as ETHLend after raising $16.2 million in an Initial Coin Offering (ICO), enabling it to create the AAVE DeFi protocol lending platform.
UNISWAP is a decentralized exchange platform without intermediaries. In other words, this is a DeFi crypto exchange, an analogue of traditional stock trading exchanges, with the only difference being that there is no physical intermediary.
UNI token holders have the opportunity to help shape the direction of UNISWAP by being able to propose and vote on them. As a UNI holder, you get to vote on things like network and policy updates, with each vote proportional to the number of UNI tokens. It should be noted that in order to be able to submit proposals to UNISWAP, you must own at least 1% of the total UNI proposal. This is quite a powerful idea for UNISWAP participants, investors really have the opportunity to influence the direction of UNISWAP, and not just hope for the best and hold on with all their might!
Buying UNI or AAVE tokens actually means betting on the technology itself and the ecosystem. In the world of traditional finance (TRADIFI), buying UNI or AAVE can be akin to buying shares in a publicly traded company such as Barclays bank or HSBC bank. As the value of bank shares rises, investors earn money. Similarly, if you have UNI or AAVE tokens and their price goes up, you profit from the increase. However, unlike stocks, you do not automatically receive dividends, but you can vote on a proposal to distribute some or all of the profits among token holders.
Investing through DeFi projects.
If we make investments through DeFi by depositing cryptocurrency into UNISWAP or AAVE, the purpose of using their liquidity pools is to earn funds by earning fees or interest.
The UNISWAP Automated Market Maker is designed to make it easier for investors to trade crypto assets in a similar way to a traditional exchange, except there is no middleman like traditional centralized exchanges. The programme connects two parties in exchange for low fees utilizing smart contracts, which are a set of rules and conditions written in software. Commissions generated from financial transactions are shared among all liquidity providers pro rata based on their exact contribution to the liquidity pool.
It is important to know what goals you are aiming to achieve as financing your funds in UNISWAP/AAVE or their tokens are two very different offerings with very different risk/reward profiles.
Expanding your DeFi portfolio with tokens is really like buying traditional stocks where the share price - and potential dividends - are the main concern, while utilizing a DeFi product to make money is about the rate of return (passive income) that you can obtain by providing liquidity to the protocol.
When providing liquidity on DeFi, you are primarily exposed to the risks of smart contracts. When you buy DeFi Governance Tokens (UNI/AAVE), you are primarily exposed to the risk that their price will drop to 0.
Profitable farming (Eng. Yield Farming).
The process of providing liquidity to a pool to generate passive earnings from its crypto assets is known as yield farming, or, literally, "growing money."
If you look at it using a banking analogy, depositing cryptocurrency into an AAVE pool is like replenishing a profitable deposit. The bank will use your funds in a larger lending pool in exchange for paying you interest. Since interest rates at regular banks are minuscule these days and no bank is willing to lend to people offering cryptocurrencies as collateral, this has created an opportunity for innovative DeFi startups to offer those with available capital in the form of digital assets the chance to get from them a reasonable return. Not surprisingly, investors are taking advantage of these high interest rates that they receive from DeFi staking/DeFi lending to increase the overall value of their holdings. This is the main thing that makes investing in Defi so attractive.
Income farming (farming) has become a very popular DeFi practice that works similar to bank loans, but this time you are the bank and earn interest on the money (cryptocurrency) you put into the DeFi system. When growing a crop, an investor deposits crypto into a lending protocol or an automated market maker to earn interest or commissions from trading or borrowing.
Risks of DeFi farming.
As with the cryptocurrency space in general, there are risks involved. There is a heavy reliance on smart contracts to enable the decentralized nature of DeFi, but these pieces of blockchain technology can still have exploits in their code that can lead to problems and loss of funds.
The use of stablecoins is another factor to consider when evaluating the overall risk of DeFi. Stablecoins are not fully – or not at all – regulated, and there have been controversies in the past about dollar reserves being unaudited and falsified. Moreover, stablecoins can lose their peg to the underlying asset and have price volatility. Of course, with anything in crypto, protecting your funds and the integrity of your wallet is important. If you give away your private key, you give away your funds.
Finally, network congestion and even fees associated with an overloaded network can be detrimental to your farming plans as it can slow down your progress and cause you to incur additional costs. Important and specific to DeFi: if you are borrowing funds, be sure to keep an eye on collateral ratios, otherwise you risk being liquidated.
Who is farming not suitable for?
Farming may be popular, but in reality, it is not for everyone. In fact, profitable farming in DeFi rewards those who have a lot of funds to invest, so it is mainly the crypto whales who believe in it first who benefit from it. Although the rate of return for defi-farming is higher than for traditional financing, this area is still quite small, given the risks and potential problems. For those who do not have much money, the return will be relatively small.
There are places where you can get 1000% APR, but often these are very small, illiquid tokens. If the project takes off, it will justify itself, but this does not happen often. Also, when running on Ethereum, for example, transaction fees alone can skyrocket to $100 when the network is congested – and those fees can eat into your profits.
Investing in DeFi.
Getting started is relatively easy, with a few simple steps using a decentralized exchange like UNISWAP, or with a wide range of tokens through an index. You can also use the good old "centralized exchange", but where is the fun in utilizing a platform with centralized management?
Both approaches have their pros and cons: with the index approach, you don't have to worry about fraudulent tokens or know which tokens are best to have, and more importantly, you don't put all your eggs in one basket, on the other hand, swapping tokens for UNISWAP gives you complete control over what you do, but it requires some knowledge of which tokens you should trade and hold.
An alternative approach could be an index like the DeFi Pulse Index.
If you're not sure which DeFi ecosystem you'd like to invest in, or would like to spread your risk across multiple DeFi tokens, you can use DeFi apps like the DeFi Pulse Index, which is a capitalization-weighted index that tracks performance. DeFi assets on the market and weighted based on the value from each token's supply. In addition, the DeFi Pulse index is designed to track projects that have significant use and aim to maintain the DeFi environment and further develop it. We could see this as something of a "simple" and safer investment strategy for beginners, but also quite viable for crypto-savvy investors who would like to hedge their stakes by financing through an index or prefer a slightly looser approach.
OSOM's Crypto Autopilot includes many DeFi tokens, and has included Uniswap, AAVE, SUSHI, MKR, and COMP multiple times in the crypto portfolio in the past. If you are planning to invest solely in DeFi, this is not the best option, but if the goal is to diversify your crypto portfolio with some of these tokens, then this option is worth considering. Crypto Autopilot is more like a traditional asset manager, but for the crypto world where AI-powered autopilot invests in DeFi among other crypto assets. Investment decisions are based on carefully selected risk parameters and constant monitoring of the markets to fine-tune the portfolio to minimize risk.
How can OSOM finance help?
Whatever you are looking for, from one-time crypto entry-exit to passive income and portfolio diversification, our algorithms will take care of it. A DeFi Earn product that aims to solve the challenges DeFi faces today by bringing together the industry's best and most trusted stablecoin lending pools into a single, intuitive user interface. Using trusted dollar-pegged stablecoins, DeFi Earn reduces risk through smart diversification.
The programme works by automatically connecting to platforms such as Binance and AAVE, gaining access to their stablecoin lending pools, and gaining interest in user assets. OSOM converts user funds into multiple stablecoins, which are then placed in credit pools.
Stablecoins can then be converted back into fiat currency. This allows OSOM users to capitalize on their savings and earn significantly higher returns than traditional bank accounts. The lowest we have seen is 3.84% and the highest is 10%. Historically, it has hovered around 6%.
With DeFi Earn, we pay fees and aggregate transactions to make them cost effective and maximize profits. We work with individuals and companies.
The world of decentralized finance represents a revolutionary, not an evolutionary stage in the history of finance. In the same way that Amazon turned the world of book selling and then retail on its head, or how Booking and Expedia changed the way hotels are booked around the world, the DeFi ecosystem is aiming to do the same with traditional finance and has already made significant progress in relatively short period of time.
Whether you choose to be a speculator/investor and invest in tokens such as UNI or AAVE, or use the same projects to generate passive earnings in the form of interest or fees, depends on your needs and risk tolerance. You can spread your risk by financing in some tokens through decentralized exchanges or lending your coins utilizing something like AAVE, or you can use a system like DeFi Earn.
It is worth keeping in mind that the DeFi crypto space is highly volatile and naturally presents the opportunity for both huge gains and big losses. To illustrate this, the DeFi market capitalization dropped from a high of $87.26 billion on May 12, 2021 to $51.47 billion on July 1, 2022. Of course, this may completely change in two months, but no one knows. Whichever way you choose to invest your funds in this crypto market - with DeFi or in DeFi - this is definitely an area of new finance that could definitely not be overlooked.
One of the main advantages of DeFi is easy access to monetary services. DeFi services can be used by anyone with a crypto wallet and internet access.
With blockchain technology, DeFi data is hаck-proof, secure, and verifiable. Every transaction on the blockchain can be viewed and verified.
DeFi applications do not require intermediaries or arbitrators. Users can control their money within the ecosystem through non-custodial cryptocurrency wallets or an escrow service based on smart contracts. The escrow service stores the tokens involved in the transaction until its conditions are met.
Once this becomes mainstream and various aspects of DeFi seep into everyday life and everyday finances, it will affect everyone from tech experts to grandmothers who don't understand what's going on behind closed doors.
So, it's time to learn how to invest in DeFi and expand your portfolio by participating in a new wave of technology-based financing.
Make sure you use key performance indicators to make the right decisions. Although the risk in DeFi is unavoidable, you can definitely minimize it by studying the indicators beforehand.
In addition, there are various investment methods, such as DeFi lending, stacking and yield farming, giving you a wide range of income opportunities.