Learn Everything about Defi and its components
Defi (Decentralized finance)
Defi (Decentralized finance) is a financial technology based on secure distributed ledgers that help you eliminate intermediaries and control banks and finance institutions have on money, financial products, and financial services. The concept of Defi is to build financial services on public blockchains. Public blockchain means the network accessible by anyone and everyone with the internet. It is necessary for Defi so people can use it for its real potential. Many individuals are using and appreciating Defi more and more because of its impeccable advantages that are hard to ignore.
Firstly, it will remove the extra fees chargeable by banks and financial companies that you pay for using their services. Decentralization makes it possible for people to do transactions without paying those fees. Next up, your money will be in a secure digital wallet instead of the physical bank. That means you will have much easy access to your hard-earned money than you have to traditional banks. It gives more sense of power and authority to your own assets. Please note that it is very convenient for anyone to use it through a simple internet connection. It will surprise you that there is no requirement for special approval for Defi. And last but not least, there is no extra hustle for transferring your funds through Defi. It can happen in a few seconds and minutes like any other digital payment method or UPI.
APY Vs. APR
There are two terms in Defi that people often use. However, some of them get confused between APY and APR. Here in this blog, we will define both the terms for you and describe their purpose. APY is the Annual Percentage Yield, while APR is the Annual Percentage Rate. APR is the interest rate on your account plus any fees that you might have to pay. On the other hand, APY is the rate you can earn through compound interest. People add interest to their initial investment with the motive of gaining more profit.
You can calculate your APR and APY through the interest rates, but you have to keep the additional factors in mind. By definition, APY will present the idea of an account’s earning potential, and APR talks about what you could owe. In most cases, while analyzing accounts APR and APY have been more accurate than the interest rate alone. However, when you compare, ensure it is the same type of interest rate. Even when looking at two contenders stack up for learning purposes, make sure you’re looking at both APR and APY, or else it could be misleading for you.
Staking Vs. Yield Farming
Before we jump into discussing whether staking is better or yield farming, we need to understand both of them individually. Yield farming is a method of developing cryptocurrency from your crypto holdings. In other words, yield farming is where you loan your cryptocurrency coins in exchange for rewards like transaction fees or interest. Extending crypto assets for Defi interest takes the decentralized concept of blockchain and applies it to finance. On the other hand, staking is the process of supporting a blockchain network and participating in transaction validation by committing your crypto assets to that network. Blockchain networks use staking as a PoS (proof of stake) as a consensus mechanism.
They sound similar as both methods require holding crypto assets to generate profits. Hence we will tell you some key differences to note between the two as below:
- Staking is an easy option for earning passive income because investors decide on the staking pool and lock in their crypto. Yield farming requires planning and strategy for choosing which tokens to lend and on which platform while continuously switching them.
- Yield farming is more popular on new DeFi projects, which can become riskier because of “rug pulls.” Rug Pulls means unknown investors who drain assets intentionally from liquidity pools. Staking needs a minimal initial investment, making it a better option for new DeFi users.
- Staking offers APY (Annual Percentage Yield) when investors lock in their funds for prolonged periods. Yield farming doesn’t require investors to lock in their funds.
Risks In Defi Staking & Yield Farming
With profits, risks come in handy. You cannot expect to earn a high profit without risking a bit. Hence, before you jump into Defi Staking & Yield Farming, we want you to be aware of all the risks you will need to take for it.
- Impermanent Loss : It is a risk that liquidity providers can run into as they lock two distinct assets worth the same amount in a liquidity pool. But, there are good chances that the price of one of them could go up or down, while the others would stay the same. It is when an impermanent loss takes place. The loss you incur when you end up with less money by investing in a liquidity pool than the value you would have had by simply keeping them in your wallet and carrying out other transactions. The loss is impermanent because there is a chance of assets coming back to equal liquidity before you withdraw them.
- Smart contracts risks : Liquidity pools and other transactions depend and work on smart contracts. Any malfunction or bugs can impede the work or allow hackers to take over investors’ funds. Involving a third party that can audit a contract would enhance the security level of your assets.
Rug pulls: As mentioned earlier, it is a scam that involves dishonest developers who create projects like liquidity pools. They run away after raising a decent amount of money from investors and never have the intention to pay back.
- Volatility Risk: The rise or fall in the value of cryptocurrency is there that makes the coins lose or gain it in a short time. Volatility risk is dangerous as it can spread from one point to affect the entire industry. In these scenarios, you can either sell your asset with a loss. Or you can continue staking if you believe in the future.
- Lock-up Periods: While staking your coins, there is a lock-up period of which you must be aware. It is the period in which you do not have access to your staked coins. Even if the prices drop, you cannot unstake them. You have to wait to regain access to your assets after the duration agreed for lock-up. The better option is to stake coins without a lock-up period to avoid the risk.
- Unguaranteed Staking Rewards: There are chances that the platform does not give the promised prizes and also that they do not pay even if they were supposed to pay. So always keep a record if you have received your promised staking rewards.
Defi Lending and borrowing
Defi lending means lending your crypto assets or crypto loans minus any intermediaries. And if you are borrowing those assets instead of lending, then it will be Defi borrowing. A borrower can directly take a loan through the decentralized platform known as P2P lending. If you are interested in lending your crypto coins, you can enlist them. It is so the borrowers can contact you for the same.
Let us discuss some features of Defi lending. Firstly, it is permissionless. So you can lend your assets at minimal costs without any need for approval. Nowadays, lending protocols offer variable interest rates that automatically adjust relatively to the supply and demand. Please note that in Defi lending, the user does not need to transfer ownership of their underlying assets. They can come and go as they like with no guidance or approval from a third party. So, if you are interested in practicing Defi lending or borrowing, you can refer to Defirate.
Also Read: How To Earn Free Bitcoin Online