How to demystify DeFi
Although the learning curve for using decentralized finance (DeFi) is steeper than with centralized exchanges, DeFi and its use of immutable smart contracts open up prospects for a more inclusive world. But how can we navigate the core functions of DeFi, use them effectively and profit?
Emerging in 2017 with the launch of MakerDAO, decentralized lending and borrowing platforms are the historical first stone of DeFi.
On the lending side, it’s all about putting your assets to work to earn interest from borrowers. On the borrowing side, it’s about depositing collateral to leverage its value, allowing the borrower to remain exposed while unlocking some immediate liquidity.
If the value of the collateral reaches the value of the loan, the collateral is liquidated to repay the debt. By creating loops — sometimes via different protocols — experienced users can make their investments go even further.
Previously, the only way to exchange one crypto asset for another was through order books on centralized exchanges like Binance or Coinbase. The arrival of Automated Market Makers (AMMs) like Uniswap or xExchange and their liquidity pools set the stage for decentralized trading, where individual users can earn a share of trading fees as income.
The principle is to deposit two crypto assets in equal proportion and receive a liquidity provider (LP) token representing the relative value of the contribution. This method of directly earning trading yields has made AMMs a fundamental part of DeFi.
Derivatives are financial products where investors can speculate on rising or falling prices. For this purpose, two parties enter into a bet, so to speak, on how a particular underlying asset will perform over a defined period of time.
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