August 11, 2021
The cryptocurrency ecosystem is flourishing, and one of the most lucrative ways for a crypto holder to interact with the market at the moment is by investing in DeFi applications. However, this activity is not without its risks. New investors need to fully understand key terms and concepts, before jumping in so as to avoid making costly mistakes.
In this article, I’ll define and explain the key terms related to this field.
What is DeFi?
To begin, we should look at what DeFi is and how it came to be. DeFi stands for decentralized finance, and refers to financial management tools developed on a blockchain or any other P2P network.
The first DeFi protocols were created around 2017, during initial coin offering (ICO) season, and mainly focused on trading ERC tokens in Ethereum. And despite the crypto crash of March 2020 (known as Black Thursday), the first half of that year became known as the summer of DeFi because of the sheer number of new projects and innovative ideas that were flying around the ecosystem.
On July 1st, 2020, the total value locked in protocols — that is, the amount of funds that users had staked in them — stood at $1.9 billion. By May 11th, 2021, is sum was $86.2 billion. That’s a more than 4,000% increase!. At the time of writing, the market is valued at
$49.8 billion, which is still a huge jump from mid-2020.
Now let’s move on to explain the key terms of DeFi trading dapps, so you can dive into them safely.
Decentralized Exchanges (DEX)
Decentralized exchanges, as the name implies, are venues where cryptocurrencies can be traded on a peer to peer basis. DEX were the first applications of Ethereum’s smart contract feature. EtherDelta was one of the first DEX to gain widespread recognition. It uses the old order book model, as do its centralized counterparts, but in peer-to-peer manner, managed by a smart contract.
Order books are pretty efficient in centralized markets and have worked for centuries. In the crypto space, however, they quickly proved to have the opposite effect. The low number of users resulted in low liquidity, which made the exchanges difficult to use, and the lack of liquidity, drove users away. This vicious cycle necessitated a new solution.
In November 2018, Uniswap was created to solve the issue. It achieved this , with the introduction of an automated market makers.
Automated market makers (AMM)
AMM exchanges are fundamentally different from order book-based exchanges. Instead of waiting for users to submit ‘ask’ and ‘bid’ orders the exchange to match, AMMs make automatic trades based on liquidity reserves for each pair. These reserves are called liquidity pools , and they are the backbone of AMM exchanges.
Uniswap specifically began to gain real traction in 2020,benefitting from the DeFi boom. It found an important purpose — giving investors a simple way of buying and trading tokens, boosting the growth of the many different dapps and tokens that were being created.
In September 2020, Sushiswap — a fork of Uniswap, was launched. It promised higher earnings by offering rewards for staking its native token. It quickly drained most of Uniswap’s liquidity,so the original DEX had to step up its game.
Around the same time, the Binance Smart Chain (BSC) was launched. BSC is the platform from which PancakeSwap a fork of SushiSwap, was launched. Sushiswap offers instant trades for BSC tokens.
Nowadays, all these exchanges are very popular, demonstrating that the AMM model is an effective way to power the DeFi market.
Liquidity pools (LP)
Liquidity pools, power AMM DEXes, by providing instant liquidity for pairs. Liquidity pools can be funded by any participant that holds enough crypto they need only to add equal values in two different tokens (e.g. KIRO and ETH), and they’ll start earning fees from each trade. The more money they deposit, the more they ’ll earn.
Liquidity pools are a great opportunity for investors since they don’t need to in order to effectively move in and out of positions. Uniswap v2, for example, charges 0.3% to transaction senders and then distributes this to all liquidity providers. Uniswap v3 allows providers to stake at three fee levels: 0.05%, 0.30%, and 1%.
Yield farming is when DeFi users stake tokens in different pools always looking for the ones that offer the best yields, usually as fast as possible.
Yield farmers look for new protocols and pairs with high annual percentage yields (APY), in order to maximize their earnings. This offers greater rewards than traditional practices, but it’ is also a lot riskier. New protocols might involve scams, and trading pairs that go up in price fast can go down with the same speed.
Annual percentage yield (APY)
APY is term that originated outside of crypto. Staking programs and liquidity pools often highlight their expected APY to lure traders The safest practice is to look for a high APY in trustworthy projects and tokens.
If you’re looking for a good place to start learning about crypto trading, we recommend joining the Kirobo Telegram group. It’s a lively community of crypto enthusiasts with a lot of knowledge flying around. Give it a try!
Disclaimer: The article is not investment advice and must be used for informational purposes only. It is very important to do your own analysis.
Citizens of Israel, Canada and the USA cannot participate in the purchase of KIRO.