Decentralized Finance – or DeFi – is a relatively new kind of financial technology that’s based on the blockchain. It was established to create a decentralized financial system: one where you can lend, borrow, and trade crypto without a financial institution running things behind the scenes.
The DeFi-verse uses smart contracts to make these things happen, instead of banks and brokerages. That way, the system is open to anybody, anywhere. You just need an internet connection, a bit of crypto, and some understanding of how to go about it.
If you want to get into DeFi, you have a ton of projects to choose from. So here’s an overview of five of the most popular ones to give you the lay of the land.
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Maker is one of the oldest DeFi projects around. It’s also one of the biggest if you look at the total value tied up in its smart contracts.
If you were to go to the bank and try to borrow money with crypto as collateral, they’d laugh you straight out the door. But on Maker’s Oasis app, your crypto is the collateral of choice – regardless of your credit score. That said, you need to deposit more collateral than you borrow so the exchange knows you’re good for the loan.
You can deposit a number of different tokens and borrow up to two-thirds of their total value. What you borrow will be in the form of DAI tokens: an “algorithmic stablecoin” that tracks the price of the dollar 1:1. And you’ll be charged interest, just like with a regular loan.
The DAI you borrow is created and added to the overall supply of tokens when you borrow it. Likewise, your DAI is removed from the token supply when you pay it back. Maker’s algorithm adjusts the interest rates on loans to influence borrower behavior. And that’s how the supply of DAI is regulated to keep its value matched with the dollar.
DAI has closely maintained its peg to the dollar since 2019 – give or take a few minor divergences – but algorithmic stablecoins do have risks. Just look at TerrUSD, which lost its peg and plunged 99% against the dollar. But this far, there’s no evidence to suggest DAI would do the same.
Maker is also home to the Maker (MKR) token, which gives holders voting rights on how the project manages its operations – kind of like how stocks give shareholders the right to vote at shareholder meetings.
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Aave is another big player in the DeFi-verse. It’s a well-known favorite among big institutional investors looking to earn income on their crypto.
Unlike Maker, you can borrow and lend different cryptoassets on Aave. As a lender, you’ll earn interest for providing the project with capital. Think of this like lending money through a bank, only the interest you earn is a much bigger piece of the pie.
When you borrow crypto on Aave, you have to pay interest and put up collateral – more than what you’re borrowing, as with Maker. And, like a mortgage, you can switch between variable and fixed interest rates.
Holders of Aave’s token (AAVE) pay lower fees on the platform, and have a say on how the project operates.
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Uniswap was the first decentralized exchange to be an “automated market maker” (AMM). Market markers provide liquidity, and Uniswap lets anybody deposit tokens into the trading pool and become one. That’s different to centralized exchanges, where most of the liquidity is provided by a handful of large market makers.
You’ll earn trading fees in return, of course – and you can pick and choose the liquidity you supply based on what you think will bring in the best yield (as a market maker, you get to set the prices at which you buy and sell). You might, for example, earn higher fees when a certain token is trading at a low price – so you could concentrate more of your liquidity at that price level.
Market making aside, you can also use Uniswap to trade some of the world’s most volatile digital investments. Many tokens list on Uniswap before they trade on centralized exchanges. This means you can buy into new crypto projects earlier on – though this can have more risk. The Uniswap token (UNI) gives holders the right to vote on any changes to the project.
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5. Curve Finance
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Curve Finance is another AMM DeFi crypto exchange. But unlike Uniswap, Curve is mostly used for trading different kinds of stablecoins.
Why trade stablecoins? DAI, for example, might be trading fractions of a cent below the dollar, while Tether’s US dollar stablecoin (USDT) is just above it. So you might decide to swap your USDT for DAI. If the price of DAI ticks back up above USDT, you could swap that back into DAI, and so on.
You’ll have to pay small trading fees for the privilege, of course, so you’ll need to know exactly what you’re doing to turn a profit. That said, you can also earn interest in Curve tokens (CRV) by providing liquidity to the protocol. When you deposit stablecoins and other crypto assets, you’ll earn a share of the trading fees from other traders. Exactly how much that is will depend on which type of asset you deposit.
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Proof of stake (PoS) is one of the ways that blockchains secure transactions. It requires users – called “validators” – to front (or “stake”) their own crypto as collateral for the network. In exchange, they get a chance to earn transaction fees.
Ethereum is expected to start using PoS to secure its transactions this year. It’s been in the works for a while, and validators have been staking ether at a minimum of 32 tokens a pop on a seperate “Beacon Chain” – that’s going to merge with the current blockchain when Ethereum becomes fully PoS.
Obviously not everyone’s got 32 ethers – or $60,000, in dollar terms – lying around to jump on the staking bandwagon. That’s where Lido comes in. The project lets you pool your ether with other stakers, essentially removing the minimum staking requirement. Plus, you can withdraw your stake whenever you want – unlike regular ether staking. Lido also offers staking pools for Solana, Polygon, Kusama, and Polkadot.
As with other DeFi projects, Lido’s token (LDO) gives holders a say on how the project is managed.
- DeFi is a relatively new kind of technology that’s based on the blockchain and aims to create a decentralized financial system.
- MakerDao lets you borrow money using crypto as collateral. Aave does too – and it lets you lend money as well.
- You can trade stablecoins on Curve Finance and volatile tokens on Uniswap – and you can pool your tokens with other investors on Lido to earn a staking yield.
This guide was produced in partnership with Ledger.