Decentralized finance, or DeFi, is one of the most talked-about aspects of the crypto ecosystem. This innovation brought forward by the amalgamation of crypto and blockchain technology is a reasonable alternative to traditional finance.
Today’s financial system is often crippled by the involvement of various intermediaries and middlemen. The potential to eliminate the intermediaries in financial transactions is a massive boon. DeFi makes that a possibility! The use cases around DeFi have opened up multiple opportunities for earning passive income. It is essential to know about DeFi to figure out how to invest in DeFi and use its true potential.
What Is DeFi?
DeFi is a kind of open finance that uses blockchain technology to remove third-party interference during financial transactions. To understand DeFi, first, let us make a small comparison with traditional finance or TradFi. Think about the intricacies involved with availing of a loan from a bank. To get a loan, one needs to pass through multiple procedures of the banking system, share a ton of private information, and then hope to get a loan at good rates. All of this takes a few days and usually includes tons of paperwork.
Now, imagine getting a loan within seconds with no paperwork and no sharing of any personal info. That is the potential of DeFi!
Different aspects of TradFi, such as lending, borrowing, trading, and insurance, are more accessible to everyone through the power of blockchain technology. Other significant benefits of DeFi include:
- Eliminating the third party during transactions reduces completion time and processing fees for using the service.
- Tamper-proof data on DeFi, ensuring security.
- Accessibility to anyone with internet access without needing approval.
- Real-time settlement of financial transactions.
- Greater transparency as all the transactions is made on the blockchain, which is visible to everyone.
DeFi allows investors to invest in this sector and make it a source of passive income. For newbies in the sector looking to make investments, here is all you need to know before investing.
The Basics of DeFi Investment
There are thousands of crypto projects that have expanded into the DeFi space. It can be challenging to differentiate between long-term DeFi platforms and cash grabs. Here are some obvious checks and balances to ensure you pick good DeFi projects.
Tip#1: If a token is offering high returns for doing nothing, it is clear that it has no value in the long run.
So it is vital to look up to the DeFi tokens with high liquidity and a solid use case. If the project only talks about the price of the native token, it is best to never look back at that project.
Tip#2: A crucial aspect of any DeFi project is the total dollar amount of tokens staked. Investors keeping their tokens, either partially or all, locked within the blockchain to support the network is known as staking. Since investors are keeping their holdings locked within the network, it implies that investors trust the project. The higher the staked volume, the better.
Tip#3: One way to learn about the DeFi programs or projects is to interact directly with them and understand the project better. Exploring the communities in Discord and Twitter helps understand the notion of other members towards the project.
How to Invest in DeFi Crypto?
DeFi projects are still in their infancy when compared to traditional finance and are gradually maturing. So, it could be a great time to invest in DeFi. One can invest in DeFi in two ways.
1. Buy DeFi coins
A simple way to invest in DeFi crypto is to buy the best DeFi tokens. But the challenge here is that there are more than 500+ DeFi tokens in the market; picking the best can be difficult. So, it is vital to research thoroughly and select the right coin for the DeFi portfolio.
2. Buy DeFi basket
Investors can buy a DeFi basket of tokens, such as the DeFi 10 Coin Set by Mudrex. It allows investors to invest in a bunch of top DeFi projects at the forefront of the DeFi ecosystem. It can be a great way to gain better risk-adjusted returns in terms of market volatility. For novice investors, starting with this basket can be a good idea to explore the crypto market.
Ways to Generate Passive Income With DeFi
Here is how to invest in DeFi to earn passive income every day.
1. HODL
HODL refers to buying a cryptocurrency and holding onto the investments in the long run. It is just like buying stocks and keeping the shares for several years to yield great returns. By HODLing, one need not have to worry about the short-term price fluctuations in the market. For example, during the Coronavirus crash in 2020, Ether was trading somewhere around $200. Investors who held onto their ETH holdings and did not panic sell would have seen its price go up to over $4000. If one had panicked and sold, the loss would have been greater, but by HODLing, investors were able to reap the profits when the market reached much higher. Every penny saved is a penny earned! So holding is one of the best ways to invest in solid and established cryptos like Bitcoin and Ethereum.
2. DeFi lending
Through DeFi lending, investors can interact directly with the borrowers through smart contracts. The whole process happens through smart contracts, thereby eliminating the risk of default or foul play. It also helps in eliminating the credit risks associated with lending in traditional finance, ensuring transparency through blockchain and smart contracts. Most lending platforms pay users an annual percentage yield or APY for locking their assets into a smart contract. So, these tokens are then used by the borrowers, who, in return, pay some interest to the lender.
For example, Compound currently offers an APY of 8.19% for lending DAI. Since smart contracts govern the process, there is no risk of the borrower failing to pay back the taken debt.
3. DeFi staking and yield farming
DeFi Staking and Yield Farming are pretty similar to each other and work as an incentive for users to hold their crypto in the long term. In staking, users can earn rewards by locking up their tokens for a fixed amount of time, depending on the operator’s plans.
Just like staking, yield farming also allows one to earn interest on crypto holdings. But it requires investors to stake crypto assets in a smart contract-based liquidity pool. For example, by serving as a liquidity provider in Uniswap, a farmer can earn returns in the form of a share in the trading fee every time an agent swaps the tokens. In contrast, depositing the tokens in Compound earns interest as these tokens are lent out to a borrower who pays the interest.
4. DeFi savings accounts
Most banks pay some interest (although in several developed economies, this is almost negligible) to people keeping their money in the bank. Similarly, when a cryptocurrency is lent to a pool, such as DAI or USDC, it can generate interest, which grows the lender’s savings. The only difference here is that the interest rates depend on the supply and demand curves rather than the dollar.
Why Invest in DeFi?
DeFi is undoubtedly the future of finance. It empowers everyday investors to access the new asset types across the globe easily. Indeed, it also reduces the fees and improves their rates. Overall, investing in DeFi can give individuals more control over crafting their financial future.
Where to Buy DeFi Tokens?
DeFi tokens can be purchased with any other cryptocurrency on an exchange. There are many exchanges in the market to buy DeFi tokens, but if an investor wants to invest in the basket of DeFi tokens, Mudrex is anyway there.
Conclusion
Decentralized finance (DeFi) is an extremely innovative solution to earn passive income on some of the best cryptocurrencies. Since DeFi is still in its nascent stages, it may be prone to vulnerabilities. However, the advantages of attractive annual performance yields are significantly higher than traditional financial institutions offer. But do not forget to do proper research before investing, staking, or lending for better results.
FAQs
1. Is the DeFi coin a good investment?
DeFi coins could be a good investment for your portfolio, being one of the niche markets growing exponentially. However, investing in DeFi coins bear the same volatility as any other cryptocurrency, so prior research before investing is necessary.
2. Which DeFi coin should I invest in?
There are many DeFi coins out there in the market. The number of coins is increasing as the sector matures. Depending on your research and preferences, one can invest in those tokens whose projects have a well-defined vision.
