Cryptocurrency and decentralized finance.

Getting started in cryptocurrency.

Welcome to my new series on cryptocurrency.

What they are, what they do and how to get involved.

This is part four of a larger series that began with learning about, What are cryptocurrencies? and continued into part two of the series with a closer look at cryptocurrency wallets and getting started in the cryptocurrency space before lastly looking at how cryptocurrency works.

These three guides will give you a solid start to exploring crypto and making your first foray into the area. I highly recommend that you read these other posts first before starting this one here.

Personal security, setting up wallets, researching tokens and managing a portfolio. Very important basics for anybody looking to know more about this area.

So what is the technology behind all of this?

What makes it all work and lets us earn interest on our investments?

Now that we have a basic understanding of how the different systems work form the previous posts. We can start exploring what one can do in the cryptocurrency space.

For this post we will start to look at the area of decentralized finance (DEFI) and different ways to generate a return on your tokens.

Introduction to Decentralized finance.

In this post about decentralized finance we are going to look at the following topics and try to gain a better understanding of these areas.

What is DEFI?
Staking tokens.
Liquidity pools.
Token swaps.

Part 1: Decentralized finance or (DEFI).

One of the uses for distributed ledger technology is DEFI. We all know aspects of the traditional financial sector where your money is held and managed by financial companies and banks.

DEFI is the next evolution of this sector where your balances are stored on the distributed ledgers instead of a banks account books. It's an emerging sector with a lot of issues in the early stages including hacks, scams, lack of regulation, self custody of funds. These are all very real issues that need to be researched before putting any money into DEFI.

As always, Do your own research.

As the industry matures and we see more and more funds moving in this direction i expect regulations and companies to catch up with peoples needs as there is money to be made and a need to be filled.

The benefit of DEFI is made up of two main things. One is the self custody of funds. You can secure your own funds in wallets as spoken about previously and have full control over their movements, use and purpose.

An issue that has really come to light in the past few years with the rise of a cashless society is institutional control of your funds. Governments using money as a way to control peoples actions and to hold it hostage against their own ideals.

When your money is held by an institution with close links to the government then it is at risk of interference. Even today if i want to move funds out of my accounts or to another account there are daily limits, questions asked and other forms of interference with my personal funds. With funds held in self custody the only real limits are based on liquidity. If there is enough money available then you can do it.

The other benefit of cutting out third parties is from a cost point of view. In the past all of these operations would have been undertaking by a third party business who would take a cut to provide the services. With self custody there can be fees depending on which blockchain that you operate but POS chains like Cosmos have tiny fees and Hive with zero fees compared to Ethereum where fees can run into the hundreds per transaction.

DEFI is sometimes called trustless banking but this isn't entirely accurate as you are trusting the code to be safe and secure whichin a lot of cases is not entirely true.

My advise in this area is to pick projects that are well established.

If it looks too good to be true, it probably is.
Check for security certificates on their site such as the Certik security audit. This example is from Cubdefi, a site based on the binance smart chain where I keep some funds in their kingdoms vault earning compounding interest every day.

The reasons why I chose their site is that the team has been building in the crypto space for a number of years. They have a visible presence. They have a good track record. The site is simple and easy to use with metamask. The site has been audited for bugs and issues. The concept is very good for beginners to DEFI. They offer multiple options for earning interest from simple staking of their native (CUB) token currently offering 52% APR. To single staking kingdoms for other tokens. Liquidity pools for multiple other tokens. And a token bridge across between ETH and BNB with more to come.

There are hundreds of larger sites offering all of these options and more across multiple blockchains so it's up to every user to research their options and see where they want to get involved. Sites on BSC such as Pancakeswap.. or on Polygon such as Sushiswap with a much larger range of offerings.

So what are the main options to earn on a DEFI site?

Part 2: Staking tokens.

This is the simplest and most basic form of earning interest in crypto.

Staking your tokens to an account for a return.

Tokens come in two forms.

Stable coins and Non-stable coins. Stable coins in theory are pegged to dollar worth of value and should always have the same value on the market.

This is the theory and while the top stable coins hold their value quite well across the entire crypto market their are also some that try to be stable but have no real value backing them to hold that position.

The benefit of staking a recognized stable coin is that in theory you will be safe form the volatile nature of the markets. We all know how the market can change from week to week so it's nice to have the option of staking and waiting.

My favorite example of this is on that old reliable of the Hive blockchain which has it's own native token (HIVE) and it's own stable coin (HBD).

This chain was my first entry point to crypto and my best investment over that whole period. They pioneered a lot of these concepts long before they became the industry standard and continue to do so.

Looking at their (HBD) stable coin the current interest rate subject to change is 20% APR. This is an amazing return on a stable coin with the added benefit of it being staked to the blockchain so that there is no third party risk of funds disappearing unless the chain itself has a meltdown. That's a highly unlikely situation as one of the longest serving crypto projects with a recognized governance structure.

All I have done for this profit is to stake the token to a savings account on the blockchain and earn 20% APR compounding every month. If you haven't looked at the power of compound interest yet then i highly recommend checking out, HBD at 20%

Their main token is part of the proof of stake eco-system that we explored in my last post and your (HIVE) balance is used for governance but also for reward distribution. By staking (HIVE) to your account, then you have a proportional say in where the daily rewards are allocated while receiving consumer rewards for your vote distribution.

It sounds complicated but isn't really and once you get used to it the system makes sense. The more stake you have, the bigger say that you have in the system and the more that you get back for your efforts.

These are my analytics from hive at current prices. You can see that i have earned almost $4,500 from writing and another $2,000 form staking. I could sell it all of my (HIVE) stake to the stable coin (HBD) but then you would miss any fluctuations in the market when the token prices rise.

All of the major platforms offer staking rewards in some form or another with various levels of risk and return. Exchanges tend to have the same with different periods of staking for returns so there are a lot of options.

Part 3: Liquidity pools.

Liquidity pools are a vital part of the new DEFI landscape. They are an integral part of the financial side of crypto as well as providing tools for interoperability as well and a method to create value for certain tokens.

From Binance academy.

What is a liquidity pool?
A liquidity pool is a collection of funds locked in a smart contract. Liquidity pools are used to facilitate decentralized trading, lending, and many more functions we’ll explore later.
Liquidity pools are the backbone of many decentralized exchanges (DEX), such as Uniswap. Users called liquidity providers (LP) add an equal value of two tokens in a pool to create a market. In exchange for providing their funds, they earn trading fees from the trades that happen in their pool, proportional to their share of the total liquidity.
As anyone can be a liquidity provider, AMMs have made market making more accessible.

The main difference between liquidity pools and staking pools is that in this case you are providing equal amounts of different tokens to provide stake on both sides of the pool.

Look at this picture from Osmosis DEX on Cosmos.

You can see in this case where I would need to provide 10 ATOM + 94.2 OSMO to add liquidity to the pool and keep it balanced. Then I would be able to earn interest on my liquidity from the pool at 23%.

This is just one example from thousands of options with returns from 1% to 100,000% depending on how early you get in and what the site is offering. Beware of sites that offer crazy returns DYOR.

Some pay out in the native token that is deposited and some pay out in their own platform token based on the value owed to the liquidity provider. These pools have a number of uses for the tokens provided that generate fees and create the interest payments or liquidity provider payments.

However there are a couple of drawbacks to providing liquidity for these pools. One is that you are no longer the owner of these funds while they are held on the exchange opening you up to risk of loss.

The other is a concept called impertinent loss which you should explore in more detail before providing funds for a liquidity pool.

The basic version is that you provide two assets to the pool of equal value. While in the pool these values can change. This change can cause you to lose money when you withdraw your share of the pool as you will likely receive different quantities of those tokens at their current market value. By holding them in your wallet these same tokens could be worth more in dollar value as the quantities of both are still the same at current market prices.

It's a subject that requires a lot of though and knowledge to understand fully but Binance academy have a good article here for further information.

Part 4: Token swaps.

The last part of the puzzle is swapping tokens with other tokens or moving tokens across blockchains.

Most Exchanges have this feature in one form or another. For a small fee they will take one token and allow you to purchase another token with it in a single move.

In this case I have 1 BNB and would like to change it into the stable coin BUSD. BNB is currently $233.31 so I will get that amount minus the small exchange fee.

Note: Most chains as mentioned earlier have some form of transaction fee that is also required to use their chain. It's important to check how much that will cost and that you have enough in your wallet to pay for the transaction.

These trades are simple and straight forward when they are all done on the same blockchain.

Sometimes you will need to move assets across chain which can be a tougher challenge and require multiple token swaps.

If I have $1000 on Binance smart chain and want a token based on Polygon then it is not that straight forward. My favorite way to do it at the moment is to convert everything into a common token that works on multiple chains like USDC.

I will now have $1000 USDC on the BSC.
Go to Anyswap for cross chain swaps.
Make sure that they have enough liquidity for my transaction.
Swap to USDC on the Polygon network.
Then buy the token on Polygon that I was looking for.

This concept is called an atomic swap but has yet to become fully user friendly. The end goal here will eventually be to put any token into an atomic swap site and receive the token required back to any chain that you specify. There are a few sites that will do this at the moment but require a hefty fee for the convenience like changelly. It works well but will cost you more for the service.

KEY TAKEAWAYS
An atomic swap is a cryptocurrency exchange between two parties that wish to exchange tokens from different blockchains.
Atomic swaps are helpful if you only have one cryptocurrency but need to use another in a transaction.
Special wallets or exchange services are needed to conduct an atomic swap because the technique is still being developed and refined.
Ref: Investopedia.

As crypto advances and develops we are seeing a lot more interoperability across chains to reach a wider market and improve the ease of use for their customers.

This will be the wider trend over the coming years and in my opinion be a vital factor in which tokens succeed or fail.

Summary.

This post is focused on the main points needed for swappping tokens, moving tokens across chains, staking tokens and adding liquidity to pools.

DEFI is a huge area that is changing rapidly every single year and while i hope that this post will give you somewhere to begin you journey in decentralized finance is just a basic overview rather than a comprehensive guide. Each of these subjects could become multiple posts by themselves and take a good level of understanding to be confident in operating in this area.

I fully recommend reading my other posts in the series along with this one to gain a better understanding of a lot of the topics mentioned here and can be found in the introduction.

The main take away for anybody looking to get started should be,

Have your wallet set up and stocked with enough to cover fees.
Be wary of new platforms or platforms offering very high returns.
Check for security certificates and history.
Recognize the different blockchains and tokens on them.
Choose the best method of earning for your level of understanding.
Browse the different options for each token.
Money makes money. There is no point in just holding when it can be put to work.