Jim Franco, DeFi Research Analyst
What is DeFi?
DeFi is short for “decentralized finance,” which refers to a new financial industry within Web3.
DeFi protocols provide users with all of the financial services you’d expect from a bank or brokerage firm, except that there are no centralized authorities. This includes the ability for users to deposit funds for interest, borrow and lend, and more. DeFi dApps (decentralized applications) use smart contracts to facilitate transactions rather than bankers or brokers.
DeFi also does not request KYC (know-your-customer) information from users. Instead, these protocols identify users based on their distinct crypto wallet addresses. All you need to do to use a DeFi dApp is connect your crypto wallet to take advantage of various services.
Sounds incredible, right? But what’s the catch?
Well, it is not very intuitive. Creating a metamask wallet alone is challenging for beginners, and most are still unfamiliar with traditional financial services.
It has a steep learning curve. However, we believe that DeFi is a key pillar of the Web3 economy and will likely impact how we transfer value in the future.
But why DeFi?
The recent centralized crypto exchange (FTX) shenanigans demonstrate that DeFi is the right path. People have lost billions, if not millions, of dollars by trusting centralized entities like banks. Remember that they are not your assets if you do not own your private keys. In traditional, banks have full control of your money and account.
The crypto ethos seeks to liberate us from this modern slavery. Humans were not designed to work for someone for 8-10 hours a day. Life is short. We should spend more time with our families and pursue our passions.
This is why we want to bring people on board with DeFi.
- To access powerful financial services that banks and corporations keep hidden from us.
- To have complete control over our assets, which cannot be taken away by anyone.
What are DeFi tokens?
How is it different from meme coins, bitcoins, etc. 🤔
DeFi tokens are cryptocurrencies linked to specific DeFi projects. These tokens frequently serve a particular case of use within each DeFi protocol’s ecosystem, classifying them as a “utility token.”
Unlike coins or security tokens, utility tokens should serve a specific purpose in their respective protocols. DeFi tokens, on the other hand, typically serve a purpose within their associated dApp.
Yes! DeFi tokens are like a coin you use to play an arcade game.
Each dApp is powered by its native utility tokens, which are mostly used in the following applications:
- Reward in the liquidity pool
- Transaction fees
- Government access
- Revenue sharing through staking
DeFi dApps or protocols, also referred to as “Money Legos,” are open-source, allowing them to communicate with each other. Because of this nature, these protocols can benefit from each other’s code and utility, creating a synergistic effect.
What’s more, guess what? Utility tokens strengthen the bonds between these protocols.
Types of DeFi Protocols
DeFi protocols are distinct in terms of responsive smart contract functionality. That is, each protocol serves a different purpose.
The majority of existing solutions are centered on: Dexes, Lending, Yield, Liquid Staking, Yield Aggregator, Algo-Stables, Synthetics, Gaming, Derivatives, Cross Chain, NFT Marketplace….wait wait there is far too much to cover. Let’s save that for the next article!
Now back to farming..
What the hell is Yield Farming?
Farming is a term that is commonly used in DeFi, particularly in the stablecoin-related category, and refers to capital investment in protocols to earn passive income.
Most DeFi protocols typically offer extra incentives to attract new users on top of the protocol’s revenue. This encourages user adoption and becomes a DeFi industry standard.
Where can I farm rewards?
- in Liquidity Pool — As a Liquidity Provider, you typically receive a share of the Liquidity Pool represented by an LP-Token. In many protocols, such as Uniswap and Curve Finance, you’ll get protocol token rewards in addition to the normal LP fees.
- in Lending Markets — As an incentive for lending your assets, protocols distribute additional rewards in the form of governance tokens. When lending in some protocols, such as Comp and Aave, you receive an interest-bearing token, such as cDAI or aUSDC.
- through Staking — Staking means entrusting your crypto assets to a smart contract in exchange for rewards and passive income. Fungible tokens or non-fungible tokens (NFTs) are assets that can be staked, and the rewards usually correspond to earning more of the same.
If you are a newcomer to the space, you must proceed with caution when it comes to farming token rewards.
Token incentives do not generate revenue or income. Instead, it is an inflationary mechanism that most protocols sacrifice to attract and retain users.
For the final section, let’s discuss the hottest trend in DeFi.
What is Real Yield?
DeFi protocols have generated millions of dollars in revenue and have seen a staggering increase in usage and adoption over the past years. However, we’ve seen skepticism about the tokenomics of certain protocols, which results in massive value destruction at the expense of retail investors.
This gave rise to improved token designs, such as Real Yield.
Projects that qualify as “Real Yield” don’t require inflationary emissions to remain relevant over time. The growth of crypto projects focusing on real yield depends on their ability to accrue new users and increase revenue generation over time to reward token holders.
Real Yield is similar to a stock dividend in which users are given direct economic benefits, such as a right to cash flows. Protocols with fee-sharing or revenue-sharing mechanisms help users have a more positive view of the crypto space in general and DeFi in particular.
How to Determine Real Yield?
A real yield protocol generates more revenue than it spends on token issuance and operational costs. Like any sustainable business model, the protocol should earn more than it pays.
To determine which projects generate a real return, you must use a DeFi financial analytics tool like Token Terminal.
I’ve written a guide navigating the platform to find protocols with actual earnings and share revenue with token holders. https://bit.ly/tokenterminal
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