DeFi beginner guide: How to invest

3 Ways to Invest in DeFi

Now that you have a better understanding of DeFi, how it works and what are the benefits, the key question would be – how could you participate? By now, you probably heard of acquaintances making it big in crypto; What exactly are they doing? That is what this article aims to address – the ways to invest in DeFi, what you are getting into and the possible rewards that you can reap.

In essence, there are 3 ways for anyone without deep technical expertise to participate in DeFi. You can do so either through crypto staking and lending with a DeFi liquidity pool, or simply a spray and pray approach.

Understanding the DeFi Crypto Liquidity Pool

Before delving more into crypto staking and lending, we need to first understand liquidity pools. Liquidity pools allow users to buy, sell and trade crypto on decentralized exchanges. It is a crowdsourced pool of crypto bound in a smart contract that is used to facilitate trades between assets. Crypto exchanges require a large sum of crypto in their liquidity pools as they want to prevent a slippage. A slippage occurs when there is a large difference in the bid-ask price on an exchange's order book, and the asset purchaser may end up paying more for an asset or receive less of the asset than expected once the trade has been executed. Exchanges rely heavily on this liquidity pool as the lower the liquidity pool, the greater the chance of a slippage when executing a trade. To put it simply, investors and traders will not be attracted to an exchange with low liquidity pools, and exchanges need help funding them.

As an individual who would like to participate in a defi crypto liquidity pool, one can do so by lending crypto or staking crypto. Lending crypto allows for individuals to earn rewards such as loan interests, while staking crypto provides token drops. In fact, it is a win-win situation for both individuals and exchanges – exchanges get a well crowdsourced liquidity pool, individual earns handsome rewards in form of consistent high yield interests or token drops.

1. Crypto Staking

Crypto staking allows individuals to earn token rewards when they stake their crypto. Crypto staking meant pledging money to a mining pool to help blockchain networks validate transactions. During this network transaction validation, miners are rewarded with more crypto or tokens. Hence in a proof of stake methodology, the more crypto a miner has, the greater chance of being chosen to validate the transaction. By pledging money, individuals help to increase the chances of the node being selected to validate transactions. In return, individuals are rewarded with tokens based on the amount they have committed.

For instance, P2P exchanges such as UniSwap allows anyone to swap ERC20 Tokens on the Ethereum blockchain. However, DeFi exchanges often require large amounts of liquidity to facilitate more efficient trades. Individuals are rewarded with a token each time new ETH/ERC20 tokens are contributed, and they may be traded on the market. Larger mining pools generate more consistent rewards, giving an incentive to investors to stake crypto with their platforms to earn passive income.

2. Crypto Lending

Crypto lending rewards individuals with consistent high yielding interests, or sometimes additional tokens on top of it. Individuals lend crypto to liquidity pools, and earn interests based on the rate offered by the company. These companies utilize the liquidity pools to offer various kinds of specialized services, bypassing centralized intermediaries through their own platforms.

There are several DeFi protocols which are used by traders to take advantage of market swings. More commonly, traders collaterize or lend their crypto to borrow stablecoins, of which they lend their stablecoins to businesses liquidity pools. A stablecoin is a cryptocurrency whose value is pegged to an external asset, and stablecoins in demand are those which are pegged to the fiat US Dollars. Businesses prefer a stablecoin liquidity pool as they are easier to manage. Imagine lending ETH or BTC, of which prices fluctuate wildly. Businesses would not be able to withstand the volatility! In fact, interest rates of stablecoins loan may go up to 25% on most exchanges.

3. Spray and Pray

Lastly, we talk about the most common methodology known as the spray and pray. Individuals would buy a range of crypto which seems to have great potential, and hope for the best. A method based on speculation, they are risky and individuals would have to exercise stringency. Furthermore, as it is hard to validate credentials of altcoin projects, it is difficult to identify a sham. Take OneCoin for example, the blockchain ponzi scheme which works on multi-level marketing. Most altcoins are poorly regulated, and individuals should exercise due diligence when including them in their portfolios.

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.

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