One of the many struggles of beginners in cryptocurrencies is the unfamiliar terms. Although some of these words make sense, others simply don't. If you're new to cryptocurrencies, you probably encounter the term DeFi, and you probably wondered what it means.
In general, DeFi is a shortened term that means decentralized finance. DeFi aims to use technology to remove the intermediaries between parties for every financial transaction. With this in mind, DeFi components are stable coins, use cases, and a software stack. Still, it's worth noting that the infrastructure and use cases for DeFi are still under development.
If you're taking an interest in DeFi as an investment opportunity, read on. In this article, we'll cover the essentials that you need to know about DeFi, so you can better grasp its system.
Without further ado, let's get into it!
What is DeFi Cryptocurrency?
As I said earlier, DeFi means decentralized finance. It is a system or software written on the blockchain that enables people to interact peer to peer.
It acts as a bridge between buyers and sellers or lenders and borrowers in a more simple term. Thus, it won't need the services of a middleman.
Such a system would result in lesser costing transactions. Further, businesses wouldn't experience the problems from the middle man. Among the common problems that DeFi resolves are commission fees, delays, and long-haul processes.
Now, you may wonder how it works.
How does DeFi work?
DeFi is a financial service without a central authority. While it involves the traditional components of a financial system, it replaces the middleman using a smart contract.
It's also describable as the merger between traditional banking services. However, it comes in blockchain technology.
DeFi lending is collateral-based. In short, a user needs to put up collateral, which often comes as ether. Ether is the token powering Ethereum.
With such, users don't give their identity or associate credit score to take a loan.
Why is DeFi so popular?
DeFi is quite popular due to Ethereum. This cryptocurrency's support for smart contracts and its ability to tokenize make all the fuss.
With all these capabilities of Ethereum, it makes the perfect innovation for the future of financing.
Since Ethereum supports smart contracts that DeFi uses, it's the reason why DeFi continues to grow than ever.
Why is DeFi important?
DeFi is essential for many people since it offers the chance to access an array of financial services.
Further, it offers a promising future to extremely high yield trading, which we call yield farming. This kind of trading allows investors to borrow and lend their cryptocurrencies at much higher rates.
It comes to the point of surpassing the rates of traditional banking and investments.
Is DeFi a good investment?
DeFi proves to many people that it's a good investment opportunity, especially if the investor knows what he's doing.
Still, the said industry is relatively young, meaning it's full of players that may exploit new investors due to the lack of technical knowledge.
Further, the prices are also currently so inflated. As a result, it’s hard to decide if current prices reflect real price discovery. Another doubt would be whether it’s just a concerted “pump” effort that will come crashing down soon.
For instance, the new protocols like AAVE have significantly increased from under $20 to over $520 in only a few weeks.
In general, DeFi is a good investment for people with deep knowledge on the matter. Further, it comes down to your available fund, as well as your risk tolerance.
How to invest in DeFi?
If you plan to invest in DeFi, you can do so in many ways. Below are three of the best ways you can follow.
DeFi tokens trading
DeFi tokens are virtual assets used by their platforms. Further, such a kind of token is also tradeable on exchanges.
If you trade these tokens, it will allow you to buy, hold, and sell when the price is right. Another thing to note is that these tokens are at the core of DeFi protocols. Thus, it unlocks their full potential.
Liquidity mining simply refers to the act of injecting liquidity into a DeFi protocol. The miners of such interact with a particular liquidity pool that holds funds.
In return, providers receive incentives to join the DeFi platforms. It's all because they receive a considerable share of the collected fees.
For instance, in a lending platform, the provider receives a percentage of fees charged to borrowers.
Still, most platforms allow LPs to withdraw the funds at any time. As a result, instead of allowing your funds to sit idly, you can be a provider and earn rewards for it.
Of course, always remember that such an act comes with risks, so you need to proceed with caution.
Yield farming is quite similar to liquidity mining. However, it comes with a twist.
For instance, rather than having the provider deposit their fund, yield farmers hunt high-yielding platforms.
A great example of such would be Yearn. In it, users deposit their funds on the said protocol. Afterward, it searches for projects with good invectives.
What is the best DeFi coin?
If you're searching for the best DeFi coin, you may want to choose among the top-performing coins. Below are the top five among the DeFi coins by market cap.
- Uniswap (UNI) - $ 31.02
- ChainLink Token (LINK) - $ 34.95
- Wrapped BTC (WBTC) - $ 57,824.98
- Luna Terra Platform (LUNA) - $ 16.42
- Aave Token (AAVE) - $ 381.26
As always, it would be best to conduct in-depth research on your chosen coin.
DeFi, or decentralized finance, is a system that uses crypto and blockchain technology. The main goal would be to manage financial transactions without the need for a middle man.
Such a system offers promising ideas for the future of financial transactions. With such, the world may enjoy transactions without costs and delays.
Of course, it still has a long way to go in terms of development. However, it remains in the eyes of every investor as the promise of a better future.