What Is DeFi & How to Invest in DeFi? The Ultimate DeFi Guide

In this definitive DeFi guide, we’ll explain everything you need to know about DeFi and what it means for the world of finance

4 min read
Key Takeaways
  • DeFi is a blanket term for the expanding ecosystem of peer-to-peer financial applications that are developed and hosted on top of blockchain networks protocols
  • DeFi has a number of benefits, including speed, transparency, anonymity and flexibility
  • However, there are also a number of downsides, such as increased responsibility on the user research comprehensively, transaction fees, and volatility
  • To get started with DeFi, you'll need a wallet and some of the currency native to the blockchain you're using. Once you have both you can intereact with DeFi apps

What Exactly Is DeFi?

You’ve probably seen the term everywhere. So, what is DeFi?

In this definitive DeFi guide, we’ll explain everything you need to know –The short answer is; Decentralized Finance, or DeFi for short. DeFi is a blanket term for the expanding ecosystem of peer-to-peer financial applications that are developed and hosted on top of blockchain networks protocols, and DeFi use cases

The basic idea behind DeFi is to create applications capable of offering the services that are typically provided in the traditional financial system such as earning interest and lending. 

DeFi banking is aiming to be a digital alternative to Wall Street by offering all the same services but in a more efficient, paperless environment that is free from third-party intermediaries. In this manner, DeFi has the potential to help create more open and fair financial markets that only require an Internet connection to access. 

These unique opportunities have unsurprisingly helped decentralized finance grow in stature. Even amid tough crypto markets in 2022, the Total Value Locked (TVL) of DeFi protocols grew from $112 billion in 2020 to $229 billion by late April 2022. 

While the TVL sits at just $28.24 billion as of early October 2022, institutional players and everyday crypto investors remain bullish on the industry, and unique components like NFTs. 

Now that we’ve answered the question about ‘what is defi crypto’ - here’s a breakdown of the ecosystem's benefits, downsides, use cases, and how it’s impacting traditional finance. 

What Are the Benefits of DeFi?

  • Open access: all you need is an internet connection and a digital wallet to interact with DeFi. 
  • Remain anonymous: No personal identification is required to utilize DeFi applications. 
  • Flexibility: You are in complete control of your assets at every step in the process, free to move them where you see fit without obtaining permission from any gatekeepers. 
  • Fast: Thanks to the automatic nature of Smart Contracts, things like interest rates and rewards are updated rapidly and offer better rates of return than can be found in banks or on Wall Street. 
  • Low-income access: Without pesky intermediaries interjecting themselves into the process, the cost of accessing financial services through DeFi technologies is significantly lower, creating more access for lower-income individuals.  
  • Transparent: The full set of transactions of DeFi platforms are available for all to see. ‍

What Are the Downsides of DeFi?

  • Transaction fees: Depending on the network being used, the fees to conduct transactions can fluctuate greatly and have the potential to be quite high during times of network congestion, especially on the Ethereum blockchain. 
  • Volatility: Many DeFi protocols are new tech and still experimental. Investments in these products can experience high volatility with the potential to go to zero. 
  • User responsibility: It's up to each individual user to take responsibility for following local laws and regulations and maintaining records for tax purposes.
  • User Error: DeFi technologies remove intermediaries, increasing the likelihood of user error that can result in the loss of funds. 

DeFi Use Cases

  • Peer-to-peer pooled lending and borrowing platforms: Individuals in the ecosystem lend out funds to earn interest. Borrowers can access these funds for a premium that is paid back to the lender. No paperwork is required. 
  • Creating monetary DeFi banking services: This mainly revolves around the issuance of stablecoins through asset collateralization. 
  • Trading: Peer-to-peer trades of DeFi crypto assets, similar to the buying and selling of stocks minus the brokerage firm. 
  • Crypto Savings accounts: DeFi interest accounts offer substantially better rates of return than those found in the legacy financial system. 
  • Derivatives: Cast long or short bets on crypto assets, in a similar manner to buying stock options or futures contracts. 
  • Token launchpads: Access newly launched projects before they are released into the wild without needing to be connected with a venture capital firm or qualify as an accredited investor. 

How to Invest in DeFi?

It’s not hard for crypto users to get involved with the DeFi space. One of the best ways to do so is buying coins like Ethereum and then using DeFi protocols that allow for lending, trading, staking, yield farming and other activities. 

Here’s a simple, three-step process to get started with DeFI investing:

  1. Select A Wallet 

Holding crypto in a secure wallet is vitally important when it comes to DeFi use cases. Crypto wallets give users autonomy over their assets by ensuring you hold private keys. Many store coins on exchanges but fail to realize these platforms own the private keys, which means they technically ‘own’ the crypto. 

Cold storage (hardware) wallets like Trezor or Ledger remain popular as they are not Internet-connected, lessening the risks of hacks and fraud. While these are more secure than their Internet-connected “hot” counterparts, cold storage wallets can be tricky for rapid traders and avid crypto users as there are extra steps needed to move coins around.

Internet-connected hot wallets like Exodus are easy to use and very accessible as crypto users can seamlessly move coins, buy, sell, and trade. However, any Internet-connected wallet is going to pose a greater security risk inherently. 

MetaMask, with more than 20 million monthly users, remains one of the most popular wallets for DeFi users. MetaMask users can operate from their browser or smartphone without having to give an email address and can connect to several well-known hardware wallets. For DeFi users, MetaMask supports NFTs along with the Ethereum, Binance, Fantom, and Polygon networks. Other popular wallets that offer DeFi access include Coinbase Wallet and Crypto.com. 

  1. Buy Digital Assets

Ethereum remains the most popular protocol to build DeFi platforms on. As a result, prospective DeFi users should start by buying Ether coins or ERC-20 tokens to participate. Other popular DeFi coins include Maker, the governance token of MakerDao and COMP, the native token of the DeFi-based lending & borrowing Compound platform. 

Uniswap, one of the most popular AAMs and a major player in the DeFi world, also has a native governance token called UNI

  1. Start Using Protocols 

Once you have crypto, it’s time to start using DeFi protocols and get involved with the ecosystem. DeFi Pulse has a comprehensive list of related platforms and tools to help with research. 

Commonly used DeFi platforms and decentralized exchanges (DEXs) include PancakeSwap, UniSwap, and Curve Finance. You can also rely on DeFi Pulse to see top-performing platforms based on TVL and understand which sectors are more popular than others. 

DeFi Stocks? How Can DeFi Mix With Traditional Finance?

As the DeFi space continues to develop, it's likely we'll see many protocols created with the aim of mixing DeFi initiatives with more traditional financial instruments like equities.

Some investors choose to add these companies to their portfolios as a diversification strategy. For example, Riot Blockchain (RIOT) and Canaan Inc (CAN) are companies focused on the crypto-mining environment. Coinbase Global, which helps provide DeFi exposure as a DeFi crypto stock, is another publicly traded company with the (COIN) ticker. 

With SOMA.finance, we're building a platform that bridges DeFi and TradFi to offer the best of both spaces. This includes offering tokenized equities and other digital assets in an easy-to-use setting that allows for faster transaction speeds, transparency, and lower fees, under the umbrella of user protection that TradFi offers.‍

How to Build a DeFi Investment Strategy

Building a DeFi investment strategy while engaging with platforms does not have to be a complicated endeavour. There’s a wide variety of tools crypto users can rely on to make money and earn passive income through DeFi protocols

Many DeFi users stake coins as part of an investment strategy to collect recurring income. With staking, a crypto holder locks up coins in a protocol for a particular amount of time and then receives interest for their commitment. 

Yield farming is another popular approach. Yield farming platforms leverage locked tokens to lend to other borrowers. Users who lock their tokens again stand to earn financial rewards for their commitment. Yield farming has become immensely popular due to the potential for massive returns on investment. 

The Future of DeFi

Despite a tough 2022 environment for crypto, DeFi continues to surge in popularity as many across the world see a more decentralized future with less influence by traditional finance. 

Many remain extremely optimistic about DeFi’s future growth prospects as younger populations like Gen Z are embracing cryptocurrency and financial literacy. Speculation is if DeFi platforms can remain transparent, make inroads on popular social media platforms like TikTok, and distinguish themselves from traditional finance - a vast amount of younger people could adopt DeFi platforms and keep using them as they grow older.

For SOMA.finance, the future of finance is a seamless global system in which opportunity transcends boundaries separating asset classes, nations and markets. This means a platform that joins TradFi and DeFi in an easy-to-use environment, and it means making traditional and decentralized assets available to everyday people no matter how much they have to invest or how far removed they are from the markets on which they are traded.

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