Crypto Investing
9 Feb 2022

The Ultimate DeFi Handbook for Investors

Ananda Banerjee

Today, I woke up to a fascinating epiphany. One that concerns making better use of our financial reserves. Lending, trading, and more without security threats and griping about centralized control… Sounds unreal, right? Well, it’s not—provided we show some ‘DeFi’ance.

But how, you ask? Read on.

Key takeaways

  • DeFi is permissionless, automated, and transparent.
  • DeFi 1.0 comes with scalability, liquidity, accessibility, and security challenges.
  • DeFi 2.0 aims to improve DeFi adoption.
  • Second-gen DeFi solutions are capable of working in tandem with traditional finance.
  • Investing in DeFi needs you to identify functional and capable projects.
  • DeFi ecosystems even support passive income generation via Liquidity Mining, Staking, DAO trades, and more.

DeFi or Decentralized Finance is more than a buzzword. It is the future of financial autonomy wrapped in the marvel that is blockchain technology. With DeFi at your disposal, it is possible to challenge the rigidities of traditional finance, especially the absence of complete ownership and personal autonomy.

But this isn’t a post about DeFi. It is a detailed guide for investors that have had DeFi on their radar for a long time now. And if you aren’t aware of the DeFi fundamentals yet, I would urge you to check out this Beginner’s Guide before moving ahead with this explanatory post.

In simple terms, though, DeFi lets you:

  • Ditch the boring paperwork,
  • Pick up transaction speeds,
  • Cut out intermediaries, 
  • Make money equal to all.

The possibilities are endless for investors looking to explore DeFi, the ultimate blockchain-specific financial ecosystem. Even though Decentralized Finance is still in its infancy, it is already taking giant strides in the virtual world. So despite the hype, buzz, and a tad bit of scepticism, it would be interesting to evaluate and analyze DeFi as an investment instrument for the future.

Honestly speaking, investing in DeFi isn’t only about seeing the relevant tokens shoot up as you trade. Instead, a DeFi investor needs to look at several aspects, opportunities, and prospects before proceeding. And those are exactly what I shall touch upon in this discussion.

Ways to Earn from DeFi

The Building Blocks of DeFi

As an existing or prospective DeFi investor, you should know its components before proceeding. And while I could go on and on about different aspects of DeFi, permissionless infrastructure, automated functionality, and transparency are the blocks that require detailing.

Permissionless financial ecosystem

To understand this better, let’s analyze how traditional finance works. If you plan on sending money to a cross-border contact, you will need to wait for the centralized intermediary to do it for you.

DeFi ensures that anyone residing anywhere in the world can be accessed and served via the virtual platform without having to rely on centralized permissions.

Automated via smart contracts

Most DeFi systems have smart contracts managing the nitty-gritty of transactions. And don’t we all know how effective smart contracts are when it comes to automating decentralized applications and even DeFi resources?

Smart contracts make DeFi products and services secure and self-acting. And unlike traditional finance, you need not look over the validity of every transaction, painstaking fund reversal issues in case of endpoint failures, and customized use cases like royalty credit, partial payments, and more.

Transparent and auditable

Everything about blockchains is transparent. And that is what DeFi takes pride in. Like every automated resource, every DeFi system has an underlying code snippet (smart contract) that makes it functional. But isn’t this the case even with the regular, real-world financial apps? Well, yes, but DeFi has every chunk of code residing on an open-source platformi.e., blockchain.

And this exclusive component ensures financial transparency, so all the capital reserves relevant to a DeFi ecosystem are always auditable.

Investment opportunities involving DeFi are curated, keeping these integral DeFi components in mind. To know more, keep reading.

DeFi 1.0 vs DeFi 2.0: Things Investors Should Know

Was DeFi not enough that you now have to deal with bifurcations as well? But then the mentioned DeFi dividei.e., DeFi 1.0 and DeFi 2.0isn’t fundamental. Instead, DeFi 2.0 is just an improvement over DeFi 1.0.

DeFi 2.0 is a set of protocol-level changes made to the existing DeFi 1.0 solution to correct its flaws and improve throughput.

But first, you need to understand what DeFi 1.0 and DeFi 2.0 mean.

What is DeFi 1.0?

DeFi 1.0 signifies the originally conceived category of decentralized financial solutions and services. And yes, it is still very much around. DeFi 1.0 is more like a regular DeFi platter, comprising Decentralized Exchanges (crypto exchanges residing on the blockchain), Decentralized Autonomous Organizations (DAOs), payment gateways, lending platforms, liquidity pools, and more.

However, despite being a smorgasbord on new-gen financial solutions, DeFi 1.0 still faces a few challenges, including security threats, lack of liquidity, volatility, and lack of accessibility.

Unsure as to what these terms mean? Read on. (If you are familiar with them, please skip this bit.)

  • DeFi security threats are more like backdoor breaches. And while combating them requires effective security measures ingrained in the DeFi protocol, what concerns investors is the lack of accountability, because in a blockchain no one person is in control or can be vilified. The question they ask is: If a breach does take place and you lose money, whom do you reach out to?
  • The crypto realm is still nascent, which means not every blockchain is brimming with millions of participants. And that is what “lack of liquidity” looks like.
  • Lack of wider adoption causes the prices of DeFi tokens to move abnormally, which might lead to an impermanent liquidity void. And trust me, getting the rescinded liquidity levels back to normal requires a lot of effort.
  • DeFi 1.0 comprises some excellent resources like DEXs and Liquidity Pools. But a self-inflicted ailment continues to affect the adoption rate. A subpar marketing planperiod. Also, the jargon and intellectual difficulty associated with these DeFi resources make them largely inaccessible.

What is DeFi 2.0?

Did you take a closer look at each of the aforementioned DeFi 1.0 challenges? Well, DeFi 2.0 comes across as the second-gen of the existing DeFi protocols, aimed at tackling each of these issues head-on.

  • DeFi 2.0 reintroduces the importance of smart contracts, which can offset investor losses via self-actuating insurances. And as compared to DeFi 1.0, DeFi 2.0 brings better security audits to smart contracts, thereby working around their immutable nature.
  • DeFi 2.0 is now both cross-chain and multi-chain. This way, it becomes possible to make the blockchains interoperable and ensure that liquidity is hardly an issue.
  • DeFi 2.0 projects are far more dependable because they observe multiple blockchains as one. And with cross-chain bridges and other resources in play, the native token volatility is a lot less than the DeFi 1.0 counterparts.
  • Finally, DeFi 2.0 doesn’t have its eyes set on taking traditional financial products and services down. And that is exactly what makes it more accessible and functional. DeFi 2.0 is designed to work with traditional finance by Oracles and APIs, thereby facilitating a higher degree of adoption.

Top deFi Projects

Should you invest in DeFi 1.0 or DeFi 2.0?

Firstly, the lines between DeFi 1.0 and DeFi 2.0 are blurry when it comes to investment. Several DeFi 1.0 solutionslike Curve, MakerDAO, and Yearn Financeare making DEXs, stablecoin applications, and liquidity pools secure and usable with incremental changes. 

And yes, the native tokens relevant to these DeFi 1.0 projects are still extremely popular. And they will have a major role to play when these projects need to work with the second generation of DeFi developments in the future.

Therefore, in 2022, there is no direct answer to the question of whether you should invest in a DeFi 1.0 project or a DeFi 2.0 powerhouse like OlympusDAO (OHM). Instead, you can follow a better approach to make DeFi investments more productive in the long run.

Best Ways to Invest in DeFi

The best way to invest in DeFi is to diversify your portfolio with highly resourceful projects. The focus, during investing, should be on getting hold of tokens that are relevant to era-defining projects. 

Purchase and HODL tokens

I am sure that all of you know how to buy tokens and coins, but selecting the right ones is the tricky part. And if you are still looking for projects that have the potential to grow multifold, here are some of our picks to give you a headstart:

  • Curve

Identified as a decentralized exchange, Curve is also a DAO, deals in stablecoin and other low-free token swaps, and even supports a liquidity pool. As an all-inclusive DeFi resource, Curve has some insane potential to make financial whereabouts safe, secure, and fast. And it is its potential and popularity that extends to its native governance token, CRV.

  • Avalanche

Despite not being an out-and-out DeFi platform, Avalanche manages to feature on this list for its smart contract ingenuity. AVAX, the native token of this ecosystem, helps users build DeFi 2.0 apps.

  • Yearn Finance

Here is a lending aggregator that sits pretty on the Ethereum blockchain. And despite being a DeFi 1.0 resource, its insurance-based abilities make it a worthy second-gen DeFi player to consider.

And while these are only a handful of tokens, you can also consider projects like MakerDAO, Algorand, Solana, and more. But then, as an investor, you should look to HODL these tokens, as the global adoption will take some time.

Keep an eye out for passive income

Investing in projects and their native tokens is more of an active form of investment. However, DeFi is arguably the only blockchain solution that lets investors enjoy passive income via:

  • Yield Farming

DeFi’s most loved blanket term, Yield Farming, helps use available digital assets, often the native project tokens, as collateral. And reinvesting returns or yields from the collateral, though optional, helps grow the concerned Yield Farm.

  • Liquidity Provisioning

Do you remember me mentioning liquidity as one major DeFi requirement? Well, Liquidity Provisioning is all about that need. Users with relevant crypto-assets can contribute to a liquidity pool, thereby increasing the ecosystem liquidity and helping traders move funds and assets. And yes, they do get paid for this and are even protected by loss insurance.

  • Lending

Probably the most straightforward use of your crypto assets, lending over a DeFi platform generates passive income. Also, smart contracts can help set up self-repayment for making lending simple and secure.

  • DAO Governance

There are times when the value of your DeFi-specific crypto asset is determined in power and position rather than money. In relevance to a DAO (Decentralized Autonomous Organization) that is about to bring a major change within the ecosystem, the native tokens are often bought and sold to gain voting and participation rights.

  • GameFi

Gaming and Finance (GameFi) have certainly overlapped in the decentralized space. Native tokens relevant to a virtual gaming platform can incentivize ownership models and play-to-earn games. This space is replete with possibilities and will require a separate, detailed discussion.

  • Staking

Don’t we all love those environmental-friendly Proof-of-Stake blockchains? Well, if you have tokens relevant to the blockchain, you can easily become a validator by staking them and earning rewards in the process.

Note: Some blockchains like Polkadot have stringent validation guidelines in place, and any sort of falsification can lead to the confiscation of the staked assets. The process is termed as Slashing Penalty.

You can invest both actively and passively in DeFi. While the active method, i.e., buying tokens and HODLing them, is time-consuming and requires patience, passive earning can overwhelm the newbies. That is why it is important to consider DeFi as a shot in the arm and a supplementary resource to the existing, traditional financial services.

Wrap-Up

As an investor, DeFi, regardless of the generation you prefer, is a space replete with productive opportunities. However, you must keep looking at the existing and upcoming use-cases to determine the efficiency and growth prospect for a given project if you wish to go with the tokens and HODLing

Also, suppose you plan to generate a steady income source with DeFi. In that case, it is important to work alongside the more popular ecosystems that already have a credible and substantial user base. To sum it up, DeFi shouldn’t be looked at in isolation. Layer-2 scaling solutions like Polygon and Polkadot are also instrumental in taking Decentralized Finance to newer heights, focusing on multi-chain bridges.

If you want to follow some DeFi projects, starting today, download the CoinSwitch App right away!

Well, that rhymed…

Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.

writer

Ananda Banerjee

Content Writer

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