DeFi (Part 1)
Let's start with understanding what DeFi is. It is short for Decentralized Finance, which means decentralized financial systems.
Without delving into intricate technical definitions, it is an alternative to the traditional financial system (banks, credit institutions, insurance companies, investment brokers, crowdfunding, etc.) that exists in various blockchains in the form of smart contracts.
In simple terms, DeFi replaces commercial banks with thousands of employees and unfavorable tariffs with automated scripts (basic programs) written by groups of programmers that operate without external interference.
Over the past couple of years, the DeFi sector has noticeably developed, and at present, there are many decentralized alternatives to services offered by the traditional financial market: lending, decentralized exchanges (DEX), payment systems, insurance, asset tokenization, financial derivatives, synthetic tokens, and even decentralized games with rewards for activity. Similar to the traditional financial market, users of decentralized products have the opportunity to generate active or passive income by ensuring their operation.
Interestingly, stablecoins became the forefathers of the DeFi market and the foundation for its rapid growth.
The increasing interest in DeFi is due to the potential returns ranging from 10% to 200% per annum in various projects at different times.
There are two main ways to invest in decentralized finance:
- Direct speculation on DeFi tokens, which involves purchasing native tokens of specific projects with the aim of selling them at a higher price later.
- Investing through DeFi products by depositing cryptocurrency into smart contracts to ensure their stable operation.
Today, we will begin by examining smart contracts and how to work with them.
In the first article, we will strive to answer the questions about what is required to invest in DeFi and how to go about it.
As mentioned earlier, the decentralized finance market comprises a vast array of smart contracts. Therefore, investors interested in working with DeFi will need custodial wallets that operate in the relevant blockchains. We have previously published information on non-custodial wallets that can be downloaded and how to set up MetaMask for use in major blockchains.
Most decentralized applications (dApps) are combinations of several smart contracts within a unified ecosystem, often with a more user-friendly interface for interaction. Historically, these applications have been predominantly located on the Ethereum blockchain, although developers are increasingly exploring other blockchains due to the excessively high fees on the Ethereum flagship blockchain.
Young GameFi projects, for instance, often prefer the Binance Smart Chain blockchain. Additionally, many Ethereum projects are transitioning to its sidechain (a parallel blockchain with the ability to directly transfer assets between it and the main chain), Polygon, where network fees are significantly lower, and the infrastructure remains the same without requiring any modifications. These projects operate simultaneously on both blockchains.
After selecting the blockchain and a wallet that works with it, the next step is to acquire native tokens: Ether for Ethereum, MATIC for Polygon, BNB for Binance Smart Chain, TRX for Tron, and so on. These tokens are primarily used to pay for any transactions on the network. Unlike balances on centralized exchanges, transaction fees within the blockchain cannot be paid with tokens that are transferred in transactions. Only native tokens of the chosen blockchain can be used, without exceptions.
The second step involves identifying a specific dApp and acquiring "wrapped" tokens on the desired blockchain. For example, Bitcoin can be purchased and transferred even in a blockchain that is not specifically designed for it, such as Ethereum, by buying Wrapped BTC (WBTC).
In the upcoming articles, we will examine specific examples of different types of dApps (decentralized applications) and the methods of working with them, along with all the nuances.
This article does not provide individual investment advice, and the financial instruments or operations mentioned in it may not be suitable for your investment profile, goals, and expectations. The material is prepared for informational purposes only and does not contain any calls to action or information that may be considered illegal at the time of publication.
Remember to conduct thorough analysis before purchasing and using any DeFi tokens.