Best Practices For Investing In DeFi Protocols And Decentralized Exchanges (DEXs)
In the years following Bitcoin’s introduction in 2009, a thriving market developed around cryptocurrency, its underlying idea, and its technology. Many specialized initiatives and businesses have emerged in the crypto and blockchain area to address a wide range of use cases.
The decentralized finance (DeFi) industry is one such subset that emerged as an alternative to conventional banking. DeFi, in particular, comprises smart contracts, which fuel DApps and protocols that operate in a decentralized fashion. Since many of the first DeFi apps were created on Ethereum, that platform continues to hold the lion’s share of the ecosystem’s total value locked (TVL).
Bitcoin (BTC) is hailed as having fundamental characteristics crucial to decentralization. However, DeFi improves upon those characteristics by including new powers.
So, how does DeFi function, exactly?
The blockchain technology that cryptocurrencies rely on is used in decentralized finance. A blockchain is a decentralized, encrypted, and publicly accessible digital ledger. Transaction processing and blockchain operation are carried out through applications known as dApps. The blockchain is a distributed ledger where users can record and verify transactions in a public ledger. If all of these parties validate a transaction, the block is sealed and encrypted, and the data from that block is included in the next block.
Blockchain gets its name from how data in successive blocks are “chained” together. There is no way to modify a blockchain because updating one block will invalidate all subsequent blocks. A blockchain’s security comes from this idea and other security mechanisms. DeFi’s potential applications center around peer-to-peer (P2P) financial transactions. In a peer-to-peer (P2P) DeFi transaction, two buyers and sellers negotiate directly to make a purchase and sale in cryptocurrency.
Decentralized exchanges (DEXs)
By eliminating the requirement for a trusted third party, users of decentralized exchanges (DEXs) can trade digital assets in a non-custodial setting. DEXs are a relatively new addition to the crypto market, but they have been there for years as a part of the DeFi sector. Participants can trade digital money with one another without having to have an account at a cryptocurrency exchange.
DEXs enable decentralized asset holding and trading via blockchain-based transactions, allowing you to retain and trade your assets whenever and wherever you like. In 2020, automated market makers, a subset of DEXs, emerged as a common means of buying and selling cryptocurrencies through the use of smart contracts and liquidity pools.Since most DEXs are designed on top of different blockchains, their compatibility is limited to that underlying technology. For instance, DEXs based on the Ethereum blockchain make trading ERC-20 tokens and other Ethereum-based assets possible.
Aggregators and wallets
Users engage with the DeFi market through aggregators. They are, at their core, decentralized asset management platforms that automatically redistribute customers’ cryptocurrency holdings over several yield-farming platforms in search of the highest possible returns.
Digital currency wallets are storage and transactional hubs. Wallets can be software, hardware, or exchange wallets, and they can store a wide variety of assets or simply one. Depending on the wallet, self-hosted wallets (wallets for which you manage the private keys) can be an integral part of the DeFi platform, allowing for various applications. Instead of managing your private keys, exchange-based wallets do it for you, leaving you with less control but also less security responsibility.
Decentralized market systems
Blockchain technology finds its most fundamental application in decentralized marketplaces. Users can conduct business with one another in a trustless manner, eliminating the need for a middleman and putting the “peer” in peer-to-peer networks. Although Ethereum, a smart contract platform, is the most popular blockchain supporting decentralized marketplaces, many others exist that let users sell or exchange nonfungible tokens (NFTs) or other specialized assets.
Why is DeFi beneficial, exactly?
The following are a few of the main benefits of DeFin.
1. Increased Effortlessness
In addition to increased safety, blockchain technology also increases transparency. Because all DeFi transactions are publicly recorded on the blockchain, all economic activity can be monitored and verified instantly.
2. Greater Ease of Obtaining Banking Services
The real benefit of DeFi is that it makes standard banking services available to people who would not otherwise have access to them. Customers in this category may need more bank accounts and credit scores to gain access to such services.
3. Save Money
Since the DeFi network eliminates the need for intermediaries, transaction fees and other associated costs associated with transferring money is drastically reduced. The final buyer benefits because they’ll have more money to spend.
4. Strengthened Financial Management
Since the DeFi system eliminates the need for intermediaries, customers have more direct access to and responsibility for managing their finances and assets.
5. Strengthened Confidentiality and Safety
All DeFi trades are publicly available on the blockchain ledger. This ensures a high level of safety and openness. Pseudonyms are held in high esteem and offer the opportunity to safeguard consumers’ personal information.
6. Possibility of Greater Gains
Higher returns are possible for consumers using DeFi compared to more conventional forms of finance. It opens up fresh possibilities for passive investment income through techniques like yield farming and liquidity provision.
Can I trust DeFi?
Due to the technology’s immaturity, unanticipated problems may arise when using DeFi. There is a high risk that startups utilizing DeFi technology would fail (startup failure is extremely prevalent) and that programming mistakes will provide hackers with valuable entry points. You could lose it completely if you put money into a failed DeFi project or use it as cold storage.
While the Federal Deposit Insurance Corporation (FDIC) protects deposits at traditional banks, DeFi platforms typically only offer protections for users’ funds if they go missing. A consumer who experiences problems with a conventional financial transaction can register a complaint with the Consumer Financial Protection Bureau (CFPB). Still, a victim of a fraudulent DeFi transaction has no such remedy.
Ways to Put Money into DeFi
Several options exist for putting money into DeFi. The quickest and easiest way to get familiar with DeFi is to purchase Ether or any coin that employs the protocol. Investing in a currency supported by DeFi gives you access to almost the entire DeFi market. Lending platforms like DeFi allow you to deposit cryptocurrencies in exchange for interest directly. The interest rate paid on your deposit may be constant, meaning it does not fluctuate with the market or variable, meaning it increases or decreases as you deposit more money.
Due to the huge demand for deposits, there is a widespread trend of “yield farming” among the various DeFi platforms. Farmers that focus on yield make deposits on the platform that offers the highest interest rate or another incentive. They keep tabs on the interest rates and incentives given by competing platforms. If another exchange begins giving a more lucrative incentive, yield growers will take their money there. Due to the ever-changing nature of incentives, yield farmers are increasingly moving their money from platform to platform.
Conclusion
Decentralized finance, or “DeFi” for short, is an emerging paradigm in money management. In contrast to the centralized financial institutions like banks and NBFCs that traditional finance uses, this system runs on a distributed ledger called the blockchain. In India, decentralized finance is still in its infancy, and its implementation is still in its infancy.
This idea is getting a bit of support as more people become aware of its potential benefits in light of the country’s growing digital footprint. Increased access to financial services, lower prices, and greater privacy and security at every stage of the transactions are just a few of the many advantages of DeFi.
Author Bio:
Prashant Pujara is the CEO of MultiQoS Technologies, a leading Mobile Application Development Services in India. They deliver high-quality on-demand marketplace app solutions and offer dedicated cross-platform developers for hire.