Hey all. Today I will be submitting my assignment for professor @stream4u for cryptoacademy season 3 week4.

1: What Is the Importance Of the DeFi System?

^{DeFi | source}

DeFi stands for decentralized finance. As the name already indicates, these are financial products on the decentralized blockchain. There are many DeFi products on various blockchains out there. However, these DeFi products are highly concentrated in the Ethereum blockchain. This is mainly due to the fact that Ethereum blockchain was the first to expand the blockchain’s utility with its smart contract feature. Now, many other chains such as Tron, Binance, etc have DeFi products in their ecosystem.

Soe of the advantages of DeFi products are:
1- No middle man: We all use numerous financial products in our everyday life. Be it for paying at a store or transferring money to a friend abroad. Did you know that you are actually being charged for every time you transact?

If the fee is not levied on you directly, the shopkeeper would definitely do it. This is the reason why there are a few shops that do charge a 2% extra fee here in India.

I myself had paid a hefty INR 5,000 fee for transferring money to my friend in Germany. This extra money goes to the middlemen involved here. In the case of DeFi, this entire concept of a middle man has been ripped apart.

I would only have to pay the mining fee if I need to transfer money on a decentralized platform which would have been much lower.

2- No central point of failure: A centralized system often has a central server where the core application is hosted. Or a few servers which run all the code. If someone is able to bring these servers done, then there would definitely be downtime in the centralized system.

DeFi on the other hand is run on millions of computers around the world. To bring down a DeFi network, an attacker would need to crash the whole internet all over the world. This is pretty much impossible. This is what makes DeFi extremely resilient.

3- Security: Apart from having a reliant network of nodes, DeFi systems are also very secure. Security of bank accounts has been compromised so many times over the years. Even now, there are so many credit card numbers that are being sold on the Deep web.

In the #case of DeFi, all the money that you own is either in your crypto wallet that’s protected by a private key or locked in a smart contract while would also be protected because, once a smart contract is deployed, no one can alter it.

4- Privacy: On a DeFi network, the actual user details are not available. This anonymity allows the user to maintain his privacy.

2: Flaws in Centralized Finance.

The centralized financial system is flawed in many ways. It is in many ways unfair for the majority of the people. Let me point out a few.
1- Inflationary: We have all come across the term inflation right? The banks have the power to increase inflation indefinitely. Take Venezuela for example. Their annual inflation is around 200,000%. This is mainly because of the banks printing the money without any limit. This has left the country’s national currency in a pathetic state. $1 is equal to 1,000,000 Venezuelan Bolivar.

2- You have no control over your money: In the DeFi world, you would know exactly what your funds are being used for. If it is a loan to someone else or is it to add more liquidity. In the centralized banks, on the other hand, your money might have been used by the banks to invest in other bonds or public sector funds, etc. You have no say in deciding what the money in your fixed deposit/ savings account would be used for. If a bank gets greedy and invests in risky financial assets, then we, the end-users have to pay the price.

This is exactly what happened in 2008’s financial recession. The banks invested in risky assets and we the end-users ended up paying the price for their mistake.

Let’s assume that the risk taken by the banks pays off. We don’t get any additional interest for our funds in the bank. All these issues do not exist in DeFi environment.

3- Central point of failure: How many of you from India have faced the server not responding issue while using Google Pay? I pretty much face this every weekend when I use one of the Nationalized banks in India.

The centralized financial systems usually have a central point of failure. This makes it an easy target for an attacker.

DeFi Products

I would like to explain two DeFi products that work exceptionally well together.
1- Wallets: Wallets are the location where your cryptocurrencies are stored. You might have already used exchange wallets such as that of Binance, WazirX, etc. These are exchange wallets and are different from DeFi wallets.

Wallets of which you own and control the private keys are the DeFi products that I am referring to over here. Some of the most prominent names in this sector include Metamask, Trustwallet, etc.

Metamask:

^{Metamask on BSC}

Metamask is probably one of the most used wallets out there. Not only does it support the Ethereum blockchain network but also other networks like the Binance Smart chain, etc.

What I love most about Metamask is its accessibility. A browser is something that all of us use on a daily basis. Metamask is a browser plugin that makes it available for me at any time I want.

Unlike the exchange wallets, we have full control over the funds in our Metamask wallet. Here, we get full control over the private keys. Consequently giving us full control over our funds. You also get to set a 12-word seed phrase using which you can also restore your wallet after you lose your private key or loss of your computer.

The way Metamask integrates with many of the other DeFi products makes it extremely useful and impossible to not have in the DeFi world.

2- Decentralized Exchanges(DEX): Most of us would be used to centralized exchanges such as WazirX, Coinbase, etc. While they are great when you are new to the crypto world, you don’t get access to several new products on centralized exchanges. This is why Decentralized exchanges are very important.

One of my favorite DEX’s are Uniswap:

Uniswap:

Uniswap: Uniswap is an AMM(Automated Market Maker) DeFi product that provides users the ability to invest in potentially new crypto projects before they make it on to a large exchange. This early access gives both the creators as well as the investors the necessary edge to make a larger impact in the world.

You can easily connect your Metamask wallet to Uniswap and search for a token that you would want to invest in and swap for other cryptocurrencies that you might hold in your wallet provided that there is liquidity available for that particular fund.

Liquidity in a DEX s added by the holders of the particular token. They can provide liquidity by adding both the token and the token pair to the liquidity pool. Like you there could be hundreds of thousands of others who do the same.

Whenever someone wants to buy or sell a token, the orders would be satisfied using the liquidity that you provided. For this, you would be rewarded a certain fee based on the amount of liquidity that you provided. This incentivizes people to provide liquidity to a token pair.

To make a token available on Uniswap, it just needs to have liquidity. A new token need not have to go through the rigorous process of getting a green signal from a centralized exchange. Anyone can provide liquidity to any tokens. Thus, making it extremely helpful to all.

Risk involved in DeFi

DeFi gives its own share of benefits. However, it is not without any risk. One needs to have a lot of knowledge before jumping into the DeFi ecosystem. Let me now take you through the risks involved.

1- Loss of Private keys: This is one of the biggest worries that many have when it comes to owning their own wallet. Private keys give you access to the funds in your wallet. If you end up losing the private key, then you would no longer have any control over the funds you own.

Since all this is in the decentralized world, you cannot call customer care to retrieve your funds either. This nightmare of losing the private keys is one that haunts us all.

2- Frauds all around: On a DEX like Uniswap anyone can provide liquidity to any tokens that they own. This might also be fake tokens worth absolutely nothing. During the peak of the Uniswap saga, there were so many fake tokens on the platform that Uniswap had started to put a warning banner asking users to check twice before investing in a random token.

3- Issues with liquidity: On a DEX, one needs to depend on the available liquidity to be able to trade. If a token pair has very little or no liquidity on the Uniswap liquidity pool, then you would not be able to swap the token.

What is Yield Farming?

In the last section, we spoke about liquidity pools and how they provide users an incentive in the form of liquidity provider fees. A new trend has also started wherein, users can stake their tokens(providing liquidity) and also start earning passive income.

The tokens staked are locked in a pool to provide liquidity. DEX like Uniswap already provides liquidity providers a certain kickback. This along with yield farming makes it extremely lucrative for investors to provide liquidity to a particular token.

Currently, there are hundreds of yield farming pools out there. Some even provide you an APY of 40%.

How does Yield Farming Work?

Yield farming is a great way to attract investors to provide liquidity for a particular token. Users around the world would not lock in their tokens without anything in return. This is why yield farming provides as much as 40% returns.

This high return is could also be that a part of the pool was used to lend money to others over an interest which is then shared amongst the investors.

Yield farming is usually used by very new projects which would need higher liquidity to be more visible to people.

7: What Are the best Yield Farming Platforms and why they are best.

Uniswap:

Uniswap was the very first DEX to see such a high volume of orders. The only reason for this is the ease of usage and the AMM model used. The incentive offered to liquidity providers was really the reason behind its great success.

^{Uniswap interest}

Uniswap is a DEX where I have seen even 200% interest per annum in a few pools. The integration of Uniswap with web 2 wallets makes it extremely easy to use your crypto tokens as well.

Recently, Uniswap released V3 of the app. This helps reduce the overall fee that we pay on the Ethereum network by implementing a batching mechanism.

All these features and a very active development team are why I feel Uniswap is great for yield farming.

Pancake Swap:

I had to include a DEX from the Binance Smart Chain mainly due to the high transaction speeds and the very low fees that make it extremely easy for anyone to trade even lower amounts. You can also take part in yield farming on the BSC chain and utilize pancake swap.

The interest might not be as great as Uniswap right now. However, being able to earn interest for just locking in your crypto in a pool is really amazing.

The feature that I love about Pankcake swap is its integration with Metamask. This allows me to have one Metamask extension for both BSC and the ETH chain(on uniswap).

The miner fee on Pancake swap is also extremely low. Thus, making even small trades possible on a DEX.

8: The Calculation method in Yield Farming Returns

You will come across 2 parameters for calculating your returns in yield farming. They are:

1- APR and
2- APY.

They might seem the same but they are very much different.

APR:

APR is the Annual Percentage Rate. This is the rate of interest that you earn without any kind of compounding involved.

So, if you put in $100 at an APR of 30%, you would be earning $30 interest in a year. However, this calculation does not take compounding into account.

APY:

Annual Percentage Yield is the rate of interest that your yield farming can earn along with the considered compounding effect.

Here is the formula that we can use to calculate profit for APY.
Profit = ((1 + r/n)n - 1) X Investment .
Where r = compounding period - i.e (40%)
n = number of days - i.e (365 days)

Let’s calculate the same for $100 yield farming with an APY of 40%.

Profit = (((1 + 0.4/365)365)-1) X 100
= (1.492-1)X100 = 0.492 X 100 = $49.2

So, the total profit is $49.2.

9: Advantages & Disadvantages Of Yield Farming

There are several advantages as well as disadvantages to yield farming.

Advantages:

1- High interest: Yield faring has been lucrative to investors for a while now. It is due to this reason that we see such great liquidity for various lesser-known crypto. One example of this would be Sparkpoint which is a relatively new token.

2- Passive income: Being able to earn money for doing nothing makes this a great source of passive income. Usually, you would have had to do some task. However, this is basically sitting and leave the rest.

Disadvantages:

1- High risk: Yield farming is extremely risky. You can think of it as a high-risk, high-return system. There have been numerous cases wherein fake and useless tokens have had massive pools. Investing in such tokens would only result in a loss.

Additionally, you would be staking your tokens for a while. This would mean that a high volatile market might cause issues.

One example of a popular yield farming project gone bad is Yam. This was hyped by a lot of people and eventually, it went from around $170 to $0.96.

Conclusion:

DeFi is definitely giving the power back to the common people. People deserve to have privacy over the funds that they own and that is not possible in a centralized system. With some amazing financial tools already out there, the DeFi ecosystem can easily replicate the functionalities of its centralized counterpart.

Yield farming is definitely a great way to grow a DEX and also to create a passive source of income.

DeFi gives you full control over your funds. So, you need to be extra careful not to click on malicious-looking links, installing unknown software. If they are malicious, you would be in a lot of trouble.