What is “DeFi" ?
This article is meant to be for those who don’t know anything about the space and would like a quick crash course
or
For people who have been aping (throwing egregious amounts of money) into stuff without understanding what anything means.
It’s not fully comprehensive but it’ll at the very least get you familiar with the terminology that people use when speaking about the ecosystem.
“DeFi” or Decentralized Finance was created as a response to the restrictive nature of “TradFi” or Traditional Finance.
From September to December in 2020, the TVL (total value locked) inside of the DeFi ecosystem ranged from around $20-25 billion dollars.
From there, DeFi started really taking off and, at its peak (November 8, 2021), the TVL inside of the DeFi ecosystem hit $110.707 billion dollars.
The TVL currently sits at $78.34 billion dollars (as of March 3, 2022).
(Information from DeFi Pulse)
TVL in this scenario isn’t used as much of a metric aside from tracking growth.
What problems is DeFi trying to solve?
DeFi seeks to give users all the financial instruments without the heavy restrictions of centralization.
In traditional finance, restrictions include access to banks, difficulties getting loans, unfair competition from corporations who have inside relationships with exchanges and banks, and overall inefficiencies when it comes to permissions.
Bullet points for more clarity:
All transactions in DeFi are transparent. You can see everything on the blockchain, a ledger consisting of all the “blocks” (records) of transactions.
Example: Wallet A swaps X amount of $AVAX into Y amount of $USDT. This transaction is permanently shown on the blockchain and anybody can see it.
DeFi is “permissionless” — to build on the DeFi ecosystem, you don’t need permission. To participate in the DeFi ecosystem, you don’t need permission. Traditional financial rules are implemented by institutions. In DeFi, financial “rules” are implemented through code or through smart contracts. Basically, the only human aspect would be through updating and managing the code via developers.
Some Terms You May Come Across
Exchanges
DEX — Decentralized Exchange (Uniswap, Sushiswap, Trader Joes, Saber, etc.)
CEX — Centralized Exchange (Coinbase, FTX, Binance, etc.)
Aggregator — protocols that scan the DeFi ecosystem and automatically find the protocol that will give you the highest APY% (yield) on your investment (ie. 1inch)
AMM — Automated Market Maker
Instead of using order books, AMMs rely on liquidity controlled by an algorithm (higher slippage if liquidity is low)
Swapping/Trading/Farming/Staking
Slippage — It takes time for a transaction to go through. That means that you may not get a coin at the same price as when you initially do the transaction. This is what’s called slippage. For a token with low liquidity, the price is more volatile, therefore higher slippage may be needed to push a transaction through. You can set slippage parameters on exchanges.
LP — Liquidity Providers
AMMs rely on liquidity so how do we get liquidity? People provide liquidity in the form of token pairs into liquidity pools (pools where you can provide liquidity). Uniswap provides information on what it means to provide liquidity and how to do it here.
IL — Impermanent Loss
So… when you provide liquidity in the form of a token pair (ie $ETH — $USDC), ideally both tokens in the pair have some sort of equilibrium. However, there are many instances when one token in the pair changes in value much faster than the other. Let’s say you provide $40,000 worth of $ETH and $40,000 worth of USDC as liquidity in a pool (you must provide equal amounts of each token in the pair). If suddenly $ETH nukes in price and you try to pull your liquidity out, you’ll realize that the value you withdraw is less than the total $80,000 you initially put into the pool. This is referred to as impermanent loss because your loss is only realized when you withdraw.
Staking — you can “stake” coins and receive rewards similar to a savings account
Pool 2 — The ultimate degen’s paradise. Usually when a ponzi farm releases, the pool with the highest risk but the highest APY% is referred to as pool 2. Why does it have the highest risk? It has the highest risk for IL. Most other pools are either single side staking (you don’t need to provide a token pair… you can simple stake one token aka no IL risk) or pools where the other token in the pair is a stablecoin. Pool 2s are usually a token pair with 2 volatile tokens. Rich or rekt.
Side note: If you ever find yourself aping into one of these ponzis, the best strategy is to simply buy the token and don’t stake. The rewards may seem juicy, but let everyone else buy the token to pile in and then dump it. There are usually locking mechanisms that prevent you from immediately unstaking your tokens once they are staked, so just buy the token, wait for a pump, and dump it all before someone else dumps on you and there’s no more liquidity you can sell into.
Collateral — If you want to take out a loan in the DeFi space, you need to deposit collateral. This is what you’ll be borrowing against.
Arbitrage — different DEXs may have different prices for certain tokens. This opens up a window for traders to “arbitrage” aka buy low on one DEX and make a quick profit by selling on another.
Miscellaneous
dAPP — Decentralized Application
decentralized programs that perform specific tasks
DAO — Decentralized Autonomous Organization
a decentralized organization (no central leadership) that is governed by the community and organized around rules enforced on a blockchain
Stablecoin — a coin that is designed to be pegged to the US Dollar
Alt coin — any coin that is not Bitcoin
PoW — Proof of Work
I won’t go into this because it’s super technical and not necessary to know right when you’re entering the space (assuming you’re entering it to make money and not for the tech lol) but you can read more here if you’re interested.
PoS — Proof of Stake
Again, won’t go into it because it’s very technical but read more here.
Whitepaper — a document that talks about the product (problems that are being solved, how they are being solved, etc.)
NFT — non-fungible token
a digital asset that can be bought or sold
Layer 1 — blockchains that are created as a solution to solve scalability (Avalanche, Solana, Luna, Fantom, Polygon, etc.)
Layer 2 — secondary solution that is built on top of an existing layer 1 blockchain (Optimism, Arbitrum, ZK Rollups)
EVM — Ethereum Virtual Machine
Making chains EVM compatible means that you can send transactions with tokens that are Ethereum compatible to and from different blockchains
Gas — gas is a reference to “fees” you have to pay to push any sort of transactions through. Gas prices fluctuate depending on how congested the network is. The reason for this is because gas is proportional to the amount of effort that computers have to make to execute a smart contract.
Smart Contract — a contract that has been programmed to execute without a third party on a blockchain.
How to Get Started (Set up)
Ok I know this can all be overwhelming but I wanted to throw in some practical advice that you can implement right away.
Once you buy tokens off a CEX (centralized exchange) like Coinbase, Binance, KuCoin, FTX, etc., let’s get them off the exchange.
If you don’t have a secure wallet, go buy one.
Easiest ones would be either Ledger or Trezor.
They have easy guides to set up inside the box.
Do not write down your seed phrases digitally.
Write them down with pen and paper and store them securely somewhere where you won’t lose them or they can’t be compromised.
You lose this, you lose everything.
Now in reference to DeFi, we need to set up wallets so that you can take full advantage of the ecosystem
For the Ethereum blockchain and other EVM compatible chains:
Metamask
Go here and download Metamask
You can choose to connect it to your hard wallet if you so choose (more security, less efficiency in regards to time because you have to confirm every transaction through your hard wallet)
EVM Compatible Chains
Avalanche ($AVAX), Binance Smart Chain ($BNB), Fantom ($FTM), and Polygon ($MATIC)
You will need to set up different wallets for these in Metamask but you will have the same address as your Ethereum address
If you click on any of the chains above, it will give you a guide on how to set up the wallet.
For Cosmos + IBC
Keplr
Go here to create a wallet for the Cosmos (Atom) ecosystem
Terra
Go here to create a wallet for the Terra (Luna) ecosystem
For Solana
Phantom
Go here to create a wallet for the Solana ecosystem
When you send your coins from a centralized exchange to these wallets, make sure you are sending the right coins to the corresponding wallets in the right ecosystem. You cannot send Solana coins to an Ethereum address.
At this point I’ve been writing for God knows how long. Obviously there are things I can elaborate on and things I’m probably missing but I tried to make this as basic but comprehensive as possible.
In the future, articles will be more focused on certain topics and will not be this broad.
Many more topics to come in the future, but now you’ll be better equipped to understand what I’m talking about.
The easiest and fastest way to get to know what’s going on is through experience.
It may feel daunting at first, but the learning curve isn’t too steep!
Hope you learned a little something and see you soon!