Is DeFi A Good Investment?

Last Updated July 23rd 2021

10 Min Read

If you’ve been an avid investor or even an attentive observer in the crypto space, you must have heard of DeFi. In the last couple of years, it has emerged as an entirely new industry within the blockchain and cryptocurrency universe.

DeFi is fast evolving into a disrupting new field of finance. But what exactly is Defi, and why is it suddenly becoming too attractive? Is it really safe to invest in the evolving industry, or are the risks just too high?

Though DeFi is looking like the “premium crypto story of 2021”, it is still important that prospective investors look deeper before they leap. If there's something we've learned in over one decade of cryptocurrency trading, it is the fact that knowledge trumps sentiment at all times.

We may not discuss everything you need to know about DeFi right here, but we will provide the knowledge you will need to make an informed decision about investing in the exciting new world of finance. Read on carefully to know the most important things about DeFi.

What Is DeFI?

DeFi stands for Decentralized Finance. It is a digital ecosystem of novel financial applications that run on several decentralized protocols. DeFi utilizes smart contracts on a blockchain, especially Ethereum, to execute financial transactions, cutting out central financial intermediaries like banks, brokerages, exchanges, etc.

By leveraging blockchain technology, DeFi offers financial instruments better than traditional institutions. It avoids the weaknesses of traditional financial institutions like slow transacting, red tape, and outdated centralized operations and systems.

Decentralized Finance facilitates a wide range of financial transactions. Users can lend and borrow funds from others, trade cryptocurrencies, speculate on price movements of crypto assets, insure against risks, and also earn interest in savings.

In addition to offering a digitalized and decentralized alternative to the traditional financial markets, DeFi offers a good number of innovations, including non-fungible tokens (NFTs), which can potentially change the crypto universe for good.

What Is The Relationship With Ethereum?

If you’ve followed DeFi closely, you must have observed that it is often linked with Ethereum and Ether (the cryptocurrency behind it, which is second only to Bitcoin in terms of market capitalization).

The reason for this relationship is because Ethereum was basically designed as an infrastructure that allows developers to build decentralized applications or dApps on top of it. The self-regulating "smart contracts" being coded to work on the Ethereum network incentivises DeFi.

Crypto asset investing is highly volatile and unregulated in some EU countries. No consumer protection. Tax on profits may apply.

Other Important Things To Know About DeFi

Before we delve further into investing in DeFi, it is important that we explain a few more things that will get you ready for this vast, rapidly evolving field of decentralized finance. You should know and consider the following factors before getting into DeFi investing:

Smart contract security

Smart contracts are more secured than centralized financial protocols, but it is not 100% secured. While smart contract security has come a long way and trumps the security of traditional financial institutions, hackers have been able to infiltrate DeFi protocols. There are few vulnerabilities that you must be aware of.

Custodial or non-custodial

As a DeFi user, you are responsible for the security of your coins, though developers are always working to fix smart contract vulnerabilities. Some protocols are designated non-custodial, which means the users are fully responsible for safeguarding their crypto assets. Custodial networks, on the other hand, requires you to transfer funds to their wallets, which is riskier.

Governance

Different DeFi projects have different governance structures. While some are run by the development team, others adopt community governance through what is generally called decentralized autonomous organizations (DOAs). Community governance is mostly the better option.

Historical data

By studying the available historical data of DeFi, you will be in a better position to make informed investment decisions. The ecosystem is pretty young, but historical data is always helpful.

How To Invest In DeFi

Just as there are different ways to make money in the field of traditional finance, there are countless ways to invest and make money in DeFi. Currently, the most viable approaches you can take include the following:

Trading DeFi Tokens

The DeFi ecosystem has tokens or cryptocurrencies that are tradable on major exchanges. Some of the popular ones are Uniswap, Chainlink, Wrapped Bitcoin, Terra, PancakeSwap, Maker, Dai, COMP, etc.

Many of the coins on the platform are promising since they are critical to the DeFi protocols. Users can buy, hold, and sell any of the coins when the price is right. The profit from regular trading on exchanges can be meaningful.

While trading DeFi Tokens, it is important to deal on the ones with provable real use cases, like governance, staking, etc. These are the factors that influence the demand, hence the price of the tokens.

Liquidity Mining

Liquidity mining involves interaction with a liquidity pool that holds funds, with the intention of injecting liquidity into the Decentralized Finance protocol. The liquidity pool is basically a concept in decentralized exchanges where you deposit an equal value of two different cryptocurrencies or stablecoins.

You can participate in liquidity mining by becoming a Liquidity provider (LP). The coins you provide will ensure that there is adequate supply when traders want to exchange one for another. For your participation, you will earn a reward proportionate to your stake in the pool – it is always a meaningful percentage of the fees charged.

A liquidity pool can be a lending platform that charges borrowers fees and distribute the profit among LPs. Instead of leaving your DeFi tokens ideal, you can join reputable lending services available in the DeFi ecosystem.

Yield Farming

Yield farming is another incredible earning opportunity exclusive to Decentralized Finance. Here, your investments are switched between different lending and liquidity pools to bring the best rates available in the market.

While it is similar to liquidity mining in many ways, it is different because the yield farmers are always on a hunt for the best platforms to earn the highest incentives. Yearn.Finance is recognized as one of the best yield farming DeFi networks. In addition to targeting DeFi projects with high yields, it considers other factors like yield profile.

Check Out: What Top 10 DeFi Cryptocurrencies Will Explode

Risks Of Investing In DeFi

Like every investment opportunity, DeFi has inherent risk. Though decentralized finance as a concept is very attractive, the risk factors can be overwhelming for beginner traders. Knowing about these risks can help you make better decisions.

The biggest risk of the DeFi ecosystem is the same risk that applies to all investments in the world of cryptocurrency. If you get locked out of your wallet, then you have lost your entire investment. However, this is avoidable. You have to develop a contingency plan for using, storing, and backing up your account information.

Besides the issues of getting locked out of your crypto wallet, experts are concerned about the amount of capital people are injecting into DeFi. Currently, more than $40 billion worth of digital assets are locked in the DeFi ecosystem, and it is set to increase further. Some analysts have warned of a potential prize bubble and regulatory scrutiny.

The type of investments you make in DeFi will also determine the level of risk you will be exposed to. Yield mining, for instance, can be very risky, especially to retail investors. Market volatility and high transaction fees can lead to big losses.

You also need to consider the technical and security risks of investing in the cryptocurrency universe. Something that is entirely not your fault (like the smart contracts holding your assets getting hacked) can result in losses. The ecosystem is relatively new and largely unaudited. Trusting the wrong network and time-locks (for DeFi staking) are other risk factors that can lead to big losses.

Rewards Of Investing In DeFi

Though investing in DeFi is risky, the rewards are enticing enough. If you are not averse to risk-taking, the rewards from investing in DeFI can be huge. Price swings are currently high, and the chances of making big profits are really high.

One of the factors that make DeFi an attractive ecosystem for investment is the fact that it is in its early days and appears to be really promising. As with most types of investments, early investors are at the advantage of being the biggest gainers.

Some of the earliest investors in DeFi have already made fortunes. Many of those who got in during the first quarter of 2020 made significant profits. Some of the best DeFi Tokens have recorded between 20x and 1000x price increases. Many liquidity mining schemes and lending protocols have paid out huge returns to investors.

DeFi is an evolving industry with lots of promises. It is really attractive, and more meaningful investments are bound to flow into the ecosystem. It is growing stronger, and many promising protocols are emerging from all directions. The rewards are still very attractive.

Crypto asset investing is highly volatile and unregulated in some EU countries. No consumer protection. Tax on profits may apply.

Final Words: Should You Invest In DeFi?

While we can’t offer you investment advice regarding Decentralized Finance, we can point out that it is really looking promising. The industry is pretty young, so it is as risky as it is promising.

From security risks like smart contract vulnerabilities to technical risks like getting locked out of your wallet, the ecosystem still has some real issues.

Moving away from the risks, DeFi can be very rewarding. The industry is young and vibrant, with several new projects that are far better than what traditional central financial intermediaries offer.

The decision to invest or not to invest in DeFi is entirely up to you, but we believe this piece helps you make the right decision for you. Your available fund and your appetite for risks will ultimately determine whether you will invest. You can also contact an expert for professional help.