In this article, we will go through the most important things that every beginner must know before investing in DeFi. This includes risks and ways to make money.
DeFi markets have lots of opportunities and risks we need to understand.
It’s important to recognize that DeFi is a high-risk investment. Every DeFi protocol and project has a different level of risk and reward. However, it’s important to recognize that the return is high because the risk is high.
There are three kinds of risks to think about:
– Technology risk
DeFi applications require smart contracts. These are collections of code that execute a set of instructions on the blockchain. Yet, if a developer’s code is weak, a DeFi protocol may be insecure.
– Asset risk
When applying for a DeFi loan, you usually put up other crypto assets as collateral. Cryptocurrencies are very volatile and their value fluctuates constantly. If there is a downturn, the crypto assets used as collateral may lose a significant amount of value. Then certain positions may be liquidated. Because of that, some people use stablecoins which are supposed to be linked to fiat and less volatile.
– Product risk
When you use DeFi, your money is not regulated or insured in the same way that it is when you use a traditional bank.
These risks are one of the reasons why experts advise only investing what you can afford to lose. As always you need to do extensive research before investing.
How to Start Earning
The majority of DeFi protocols use Ethereum or Binance Smart Chain. The number of alternative blockchain networks that allow smart contracts is expanding. Before using DeFi services you need to choose a blockchain network.
In order to be able to access the DeFi protocol, you need to have a wallet that supports it. Wallet extensions like MetaMask make it easy to swap between networks like Etheruem, Binance Smart Chain, and Polygon. Metamask is a browser wallet, and there are also mobile wallets.
The last thing before you are ready to use DeFi, you need to buy the relevant coin for DeFi protocol. Most DeFi protocols live on Ethereum and BSC. If the DeFi protocol lives on Ethereum, you need to buy ETH. If DeFi protocol lives on BSC, you need to buy BNB.
What to do with DeFi?
There are many ways to work with DeFi, here are some examples:
- Buying crypto
Many newer cryptocurrencies are not available at centralized exchanges. Also, many centralized exchanges are not available in all countries. A big advantage of Decentralized Exchanges is that registration and KYC procedure is not required.
The largest exchange on the Ethereum network is Uniswap and on the BSC is Pancakeswap. The procedure is quite simple. It is necessary to connect the wallet with the protocol and have the amount of the native token on it.
DeFi protocols aim to make it simple to lend and borrow cryptocurrencies without the use of middlemen. Interest rates are determined by supply and demand. As a result, they fluctuate over time. To ensure that lenders get paid back as a result of market instability, most regulations require borrowers to overcollateralize their loans.
- Liquidity mining
Pre-funded liquidity pools replace traditional order books. Liquidity pools contain both of the assets in a trading pair. Users provide liquidity in these pools, and then they earn fees from trades on that pair. Users earn money by simply contributing liquidity to these pools, which is known as liquidity mining.
- Yield Farming
Yield farming is another name for yield or liquidity harvesting. It involves lending cryptocurrencies. When you lend cryptocurrency in yield farming, you earn interest and sometimes fees. The interest you earn in the form of a new cryptocurrency is most of your returns. In fact, the portion from fees is small. If the coin appreciates quickly then you really have a chance to make big money.
The most attractive aspect of DeFi is financial services without KYC and AML procedures. It’s a big reason for its rapid growth. The DeFi community may remain completely anonymous while taking advantage of the services on offer, which includes everything from trading to taking out loans.
As the DeFi world evolves to even greater automation, passive income is becoming extremely important.
Investing, on the other hand, is not without risk. There is no governance to identify the good from the bad in the Trustless and Permissionless world of DeFi.
The following are some suggestions for beginners:
- Avoid investing in unaudited processes unless you are completely aware of the risks and can afford to lose money.
- Don’t put money into investments that you can’t afford to lose. There are a lot of Ponzi schemes out there.
- Do some research to identify protocols that are likely to continue to exist in the future. The longer the vesting periods and incentives for communities to stay put, the better.
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