by Jake Wengroff
A Quick DeFi Primer
Decentralized finance, or DeFi, refers to financial systems that are enabled by decentralized blockchain technology. DeFi is specifically associated with the Ethereum blockchain and all of the cryptocurrencies built on it.
DeFi technology creates decentralized money and eliminates the necessity of government-controlled central banks to issue and regulate currency. While this perspective can be interpreted as a way for DeFi to circumvent regulation or oversight, DeFi technology instead delivers much-needed, in-demand blockchain-based solutions for financial services companies, including savings accounts, loans, insurance and other traditional products. In this regard, DeFi is helping the blockchain and cryptocurrency markets mature, by enabling the delivery of financial services that more conservative banking or investing clients are interested in.
Perhaps the most traditional functions enabled by DeFi, borrowing and lending services are available to cryptocurrency users. Those who own substantial amounts of cryptocurrency but want liquidity in other currencies can borrow money by using their cryptocurrency holdings as collateral. Individuals can lend their cryptocurrency deposits to earn interest from borrowers, thereby profiting from the values of their holdings without triggering taxable events. The apps that facilitate this decentralized borrowing and lending are designed so that interest rates automatically adjust based on the changing supply and demand of the cryptocurrency.
How to Invest in DeFi
There are several ways to invest in DeFi. Let’s review a few of them.
The simplest option, which provides only general exposure to DeFi, is to buy Ether or another coin that uses DeFi technology. According to the Motley Fool, buying a DeFi-powered coin confers exposure to nearly the entire DeFi industry.
Trade DeFi Tokens
Another way to invest in DeFi is to trade tokens representing DeFi networks, applications or protocols. Rather than simply buying Ether and holding on to it for a period of time, this investing strategy includes high volume buying and selling, and is not for the faint of heart. High volatility and risk is involved in trading these DeFi assets, yet opportunities abound. Some of these DeFi tokens include Uniswap (UNI), Terra (LUNA), Wrapped Bitcoin (WBTC) and Chainlink (LINK).
You can deposit cryptocurrency with a DeFi lending platform directly in order to earn interest on your holdings. Defi lending can benefit both lenders and borrowers. It offers margin trading options, as well as allows long-term investors to lend assets and earn higher interest rates. As with traditional banking products like CDs, you can receive higher interest rates if you are willing to deposit funds for longer terms, and the interest rate paid on your deposit can be either fixed or variable.
Since demand for deposits is high among the various DeFi platforms, a practice called “yield farming” has emerged. Yield farmers deposit funds on whichever platform pays the highest interest rate or other incentive, and they continually monitor the current interest rates and incentives offered by other platforms. If another platform starts offering a better incentive, then the yield farmers maximize their profits by moving their deposits to the other platform. As incentives constantly fluctuate, yield farmers continue to move their funds from platform to platform. Yield farming can actually be performed passively, using automated market maker protocols.
In DeFi staking, users lock or hold their funds in a crypto wallet to participate in maintaining the operations of a proof-of-stake (PoS) based blockchain system, and in return get a predefined interest rate. Staking can be seen as a hybrid strategy: You’re investing in a PoS blockchain system, but receiving income based on an interest rate. The total amount of cryptocurrency assets staked on DeFi platforms is worth around $21 to $23 billion, as of January 2021.
Passive DeFi Funds
Another way to invest in the DeFi ecosystem is through funds and trusts. This is the most passive, “novice friendly” way to get exposure to DeFi, explains Tal Elyashiv in TheStreet.com. Some examples are Bitwise’s DeFi Index Fund, Grayscale’s Diversified DeFi fund, and Galaxy Digital’s DeFi index tracker fund.
Investing in DeFi with Greater Peace of Mind
While DeFi enables any two parties to securely and directly transact without involving an intermediary or central authority, investors are still subject to security vulnerabilities inherent in the various wallets and exchanges through which they buy, sell and trade their crypto. Once assets are compromised, a cybercriminal obtains the private key for a customer’s crypto assets and can easily move the assets to another wallet.
The industry needs market-driven solutions that can keep up with the ever-evolving DeFi space. TransitNet is creating the industry’s first third-party title registry that demonstrates proof of ownership of crypto assets, to add a layer of protection for investors whether they are simply buying and holding Ether or are actively trading on an exchange.
Join the forefront of the new crypto infrastructure.
Jake Wengroff writes about technology and financial services. A former technology reporter for CBS Radio, he covers such topics as security, mobility, e-commerce and IoT.
Motley Fool – Defining DeFi
TheStreet.com – DeFi 101: Decentralized Finance and How To Invest in it
CoinMarketCap – Crypto Staking Guide 2021