I’m back with another two minute explainer video! This time I’m tackling ...DeFi.
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What defi? We’ll start by defining it and then dive into what Defi tools have already existed in the market and then what this new wave of Defi is all about.
Defi stands for decentralized finance and is a wide overarching term used to describe various financial tools within the blockchain eco-system. It essentially leverages decentralized networks to transform old financial products into trustless protocols that run without intermediaries.
There are several DeFi tools that have existed for a while - things such as decentralized exchanges also known as DEX’s, lending platforms, stable coins and prediction markets… but what is this new wave of defi all about?
Well, you may have heard the term “hodling” where people essentially hold their cryptocurrency long term and the gains that they make are based on the price of the coin going up - in contrast these new DeFi tools offer a more complex, potentially more rewarding, but certainly riskier way to earn with your crypto.
Two of the most popular tools are yield farming and liquidity pools - so let’s dive into what those mean.
Yield Farming - essentially the process of earning returns, or yields on your capital by putting it to more productive use. Money markets offer the simplest way to earn yields on your crypto and this setup is optimal for financial speculators who want to obtain leverage on their capital
Now Liquidity pools may offer better yields than money markets, but there is additional market risk.
How that works is platforms such as Uniswap offer liquidity providers (LPs) with fees as a reward for adding their assets to a pool. Liquidity pools are generally configured between two assets in a 50-50 ratio and LP’s earn a fee for helping to facilitate the market. However, there is risk of impermanent loss, which is the loss created by providing liquidity for an asset that could rapidly change in value. For example - if you were an LP for an ethereum and a particular defi coin pool and the price of the defi coin suddenly plummets… it would try to rebalance - meaning you could see a loss of your original ethereum.
There are a lot of different ways to interact with these financial instruments and the right setup for each person really varies based on the amount of capital you have, your investment timeline, and your desired level of risk.
Please be careful as there are many scams in this new emerging market and so always do your own research before investing .
I hope you found this video helpful and i’ll be back soon with more 2 minute blockchain explainer videos.
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