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Hello friends, it has been an engaging season with advance participation classes with other like minds and knowledge shared from our individual posts. For this week, i will be attempting homework tasks presented by Prof @stream4u on CeFi-DeFi-Yield. Lets read through as I lead...
>1.What Is the Importance Of the DeFi System?
The Decentralized System which was seen to evolve from the continued ineffectiveness and inefficiencies from the centralized system has been saddled with alot of importance. It is simply a financial system that is built on the blockchain protocol that is seen to guarantee decentralization in all of its processes.
The DeFi system is observed to guarantee complete ownership of operation to its user without any form of unitary command system in place to regulate the use or operation of user account. That is is to say, users can freely and independently operate in the DeFi system void of any decision body gagging its freedom of expression and operation.
Permissionless_ This feature that accompanies all decentralized protocols is to ensure it removes over dependency on intermediaries rather work specifically with smart contracts which are likened to be enforceable automated rules of agreements before a consensus is reached for a guaranteed and completed transaction.
The DeFi system has made it possible for users to receive the appropriate ROI as rewarded in the system operation. In the CeFi system, it is known that users entrust their assets to third party agents or intermediaries who assume more of the percentage reward when these assets must have been used with or without their consent. In this case, the DeFi provides complete compensation of rewards to its liquidity providers.
Increase Earnings in platform: This DeFi concept allows the User to earn each time liquidity is provided in the system by means of trading fees paid by borrowers in the system. This allows for increased earning rewards from the DeFi system vis-a-vis the CeFi system where the intermediaries are seen to earn more than the liquidity providers.
Moreso, the DeFi ensures great security protocols which guarantees the safety of user assets invested in the system. This Protocol works basically with the blockchain technologies which ensures that consensus agreement are reached from the different nodes before transactions are completed.
Immutability_This is a singular feature that has brought great importance to the DeFi which makes it impossible for completed transactions to be altered while they are are stored in the blockchain. This has also given a hand of fellowship in promoting Transparency as well as boost confidence amongst users.
Interoperability_Just as we observed the feature of Immutability, this feature makes it difficult for hackers to alter processing transactions. There is an end to end protection of transaction without possibility of been altered before they are completed.
>2.Flaws in Centralized Finance.
Since the emergence of the DeFi there are some visible flaws found in the CeFi system which endangers it. The Centralized finance is seen to operate from a unitary source which sees it to attract more risks at the unit of command and to itself alone, hence exposes it to great loss of assets if there are cases of any eventualities like seen in the 2008 financial crisis.
The Centralized Finance are prone to security breach unlike what is seen in the decentralized Finance that works on the blockchain technology with conglomeration of different nodes reaching a consensus agreement. There are unrelenting cases of system hacks which are detrimental to users assets/investments.
Increased cost of Transactions/Activities of Middlemen: Also, there are activities of intermediaries or third part agents which increases the cost of using the CeFi system and also exposes the user to malware attack and in some cases undermine the system regulations. Intermediaries here may include brokers, insurers, auditors etc. This is also seen to reduce or slow transaction process and man hours lost in achieving a given purpose.
Difficulty in enrollment: There are perceived difficulty in on-boarding new users into the CeFi system due to its long and laborious documentation processes during KYC. This has made it look so difficulty vis-a-vis the DeFi system with little or no documentation process.
Lack of reach to many and perceived inequality in the management of system process. This has remained an issue as the well placed in the society are seen to have dominance over low placed in the society without recourse to the anomaly.
>3.DeFi Products. (Explain any 2 Products in detail)
DeFi has continue to bring all closer to the financial world by leveraging on the the blockchain technology that encourages a trustless and transparent system. Will be handling the two major aspects of the DeFi products;
**Decentralized Exchanges**
This is one of the main feature or products of the DeFi which provides a platform for its teaming users to transact seamlessly. So far this platform has provided a trustless and transparent process that sees the introduction of so many trading pairs in its platform. Transactions captured in this series included asset swapping/Exchanges, buy/sell activities, Providing liquidity etc. Users in the exchange platform are captured to transact at will without any form of third part interference or activities which we've seen already as one of the flaws in the centralized systems where they either increase the cost of process participation, slow its process or exposes users to malware attack.
This brings us to the Modus-Operandi of how this DEX works since there are no third party activities seen in between users and the system. It is known to use the Automated Market Maker (AMM) which happens to be an automated agreement enforcement tool that ensures the user meets the exchange requirement before transactions are consummated. There are several DEX seen in operation today which include the Justswap, Uniswap, Matcha, OpenSea,Oasis, Kyber Network, dydX, Bancor etc.
For example the Uniswap is seen as the first permissionless decentralized exchange with access to all users of the Ethereum coins to trade using their web wallets especially that of web 3.0 wallet. Swapping and exchanging the ERC20 was seamless with a zero documentation process during on-boarding. It has a relatively little or no cost for transaction that goes through it due to its lo gas fees and flexibility seen in providing liquidity.
More interestingly, Uniswap was able to provide different tiers of providing liquidity vis-a-vis fee charges which depends of users capacity and risk level ranging from 0.05%, ).30% and 1.00% respectively. This different tiers would align users on preference for which is suitable for them based on their capacity.
**LENDING**
This i will say is one of the main stay of the DeFi product with capability of providing liquidity to users aside swapping/Exchanging their assets as seen above. This allows users to provide liquidity into a liquidity pool and also earn rewards from trading fees paid by borrowers of liquidity from the pool. Invariably, this is a sure way of making passive income by any user who provided liquidity in the pool.
There are so many in this category which include JustLend, Aave, bZx, BlockFi, Compound, Nexo, CoinList, Curve, Maker etc. I have once used the JustLEnd and i would say this is a fantastic Lending App that accords both lenders and borrowers the opportunity to use tokens of their preference. The JustLend can be accessed from the TRONLINK, that is to say it was built on the TRON blockchain.
This is a typical illustration on how to get this App.
- Launch your Tronlink App
- Click on the Discover form the Down side of your screen
- Click on the JustLend icon as shown o the screen
>4.Risk involved in DeFi.
- *Loss of Private Key*: Just as known of a typical decentralized platform where the security and ownership of account lays solely on the user, loss of keys means permanent loss of assets forever since there are no option for password recovery.
- *Issues of Forced Liquidation*: Due to market volatility, when values of staked asset are depreciated beyond the set 50-60% DeFi protocol of Loan To Value ratio , there is what we call Forced Liquidation which hampers the activity of the user for an emergency repayment.
- *Impermanent Loss*: This is simply when the value of an assets stake is seen to depreciate lower than when it was deposited into the pool. These are more in occurrence with pools that are made of volatile assets than those with the stable assets (Stable coins).
- *High Cost of Transaction*: Most of the DeFi application are built on the Ethereum Blockchain and hence there are larger TPS seen passing through its chain which causes congestion and slow in transaction and scalability. This impacts also impacts on the gas fees charged in transaction which makes it difficulty for all users to continue to engage DeFi applications vis-a-vis its financial risks.
>5.What is Yield Farming?
This is one of the best practices introduced in the DeFi that has continued to attract more liquidity into the system vis-a-vis its CeFi where investors liquidity are repaid with little or no interest in some cases. This is a method that rewards liquidity providers of their staked assets in the pool. Liquidity providers are seen to lock up their assets for a period of time and earn rewards accordingly based on the APY/APR.
This is typical of the Fixed deposit seen in the CeFi where users are paid some certain amount in return and their money used for other lending projects. The intermediaries are seen to always get the larger chunk of the interest earned unlike what the Yield farming offers to its users in the DeFi where they are repaid based on the trading fees paid by the borrowers of these funds. *It is another form of making passive income in the cryptocurrency space*.
>6.How does Yield Farming Work?
Just as explained above, the process of Yield farming starts with the user who happens to stake or lock some of amount of tokens into the pool. In this case they are referred to as liquidity providers. They are seen to provide liquidity into the pool which activates the pool which buyers and sellers are seen to interact. When this is done, the liquidity provider is rest assured of the passive income to be received from the trading fees charged by the borrower of this tokens i the pool. The user can also decide to invest back the reward gotten or as well as look out for other higher yield fields to reinvest for more %APY.
It is advisable that tokens deposited should be stable coins to retain the value of assets in pool which usually void of depreciation and market volatility. In all of this the AMM is seen to play a critical role of quoting price of assets in the pool at any given time. AMM is the automated agreement enforcement tool in the protocol and a reliable technology used by most DeFi protocols in quoting of assets prices in the decentralized exchanges.
*Some highlights on How Yield Farming Works*
- Users are seen to lock up assets in the liquidity pool; they are known as the liquidity providers.
- Due to the rising issues of impermanent Loss, deposited or locked up assets should be stable coins/assets
- Distribution of reward is specifically done based in the volume of assets locked up on pool.
- there are flexibility seen in reinvestment of rewards to other liquidity pools
- the concept of Yield Farming does not only stop at providing liquidity but when this liquidity has been borrowed out we can say it has been complete end to end.
>7.What Are the best Yield Farming Platforms and why they are best. (Explain any 2 in detail)
**The Compound Finance**
The Compound Finance is a typical example of the yield farming platforms which was founded in 2017 by Geoffrey Hayes and Robert Leshner and headquartered in San Francisco, California. It is seen to be built on the Ethereum Blockchain with its numerous users and developers who are also building on its protocols since it runs an open source interest rate protocols which was gathered as an attractive feature to developers in unlocking other new financial applications. It completely aligns with web interfaces that sees it adjust interest rates bases on the specificity of assets demand and supply.
It may be regarded as a public money marketplace which hits the presence of investors who come to utilize its protocol in with exchanging, lending or borrowing as the case maybe. The Compound Finance allows users to have a seamless ability to borrow and lend assets at will especially with those having the Ethereum wallets who can provide liquidity.
Compound finance DEX has been very useful as it has removed the bureaucracy feud between providers of liquidity and their borrowers. The AMM model which happens to be incharge in handling quoting of prices, rates and other collaterals are all under the smart contracts. Therefore individual parties interact with the system directly.
When we deposit out tokens into the pool, we are to get the corresponding interest rate for such coin. For example, when we deposit ETH into the pool we are to get the cETH, when we deposit USDT, we will CET cUSDT. In some cases where we deposit multiple tokens, we are expected to get the individual interest rate for each of them.
Some of the supported tokens seen in the Compound protocol include; ETH, USDC, USDT,REP,ZRX,BAT DAI & WBTC.
**PancakeSwap**
Funnily this is a 2020 invention that came into limelight and has already taking the spotlight in the cryptocurrency space. It is a BSC Decentralized Exchange with basic intentions of the anonymous developers on breakfast foods and rabbits. Just as other yield farming, it uses the Automated Market Maker (AMM) tool which guarantees an automated quoting of prices in the liquidity pool and trades done directly with the pool without intermediaries.
This platform primarily allows users to buy/sell and swap and exchange assets in the ecosystem with possibility of trading BEP-20 tokens also and earn rewards. What is locked up for faring is what we receive as token in rewards, for example when we add the BNB and USDT in the pool we will definitely earn BNB-USDT LP tokens in reward.
The PancakeSwap is seen to be alittle more robust in its synchronization with other wallets like the trust-wallets, Metamask wallets, Binance chain wallets, Walletconnect etc. This wallets can be unlocked as soon as we click on the unlock wallet options when we launch the PancakeSwap. It is worthy of note to use more of the stablecoins while adding tokens in the pool so as to reduces issues of impermanent Loss as this is one of the main loss factors in the liquidity platforms.
>8.The Calculation method in Yield Farming Returns.
There are two parameters we will always see when it comes to calculating Yield Farming Returns which include the;
- The APR: Without much complicity, this simply means the % accrued returns to user without any compounding interest formulation done annually. This means the given interest rate for a yield farm is the value after multiplying the added value locked up.
For example if I added $100 worth of token in the pool at 100% APR,
This means, $100 x 100% = $100 (interest reward annually)
therefore, at the end of the year i should be having $200
($100 as initial Investment , $100 as APR)
- The APY: On the other hand, this is the APR done with the compounding interest now. So this is major difference between this both parameters.
This is computed using the formula = (1+r/n)ñ -1
Then using the same details as seen above;
Value of asset added - $100
%APY = 100%
then my APY here would be = (1+1/365)³⁶⁵ -1
= (1+0.0002739726)³⁶⁵ -1
= (1.002739726)³⁶⁵ -1
= 2.714567482 -1
= 1.714567482
Therefore the %APY on the amounted added to pool is = 1.714567482 x $100
= $171.4567482
Total Investment after a year would be = APY + Value locked up
= $171.4567482 + $100
= $271.4567482
>9.Advantages & Disadvantages Of Yield Farming.
**Advantages**
- Yield Farming allows for more earnings to its users. Holders of such assets in the liquidity pool are seen to have variable return in earnings for having and holding assets in the yield farming pool.
- Easy of Participation and On-boarding into platform. In this case, there is free entry into the platform as there are little or no documentation processes required to join and as well as opened to all irrespective of boundaries.
- It is a decentralized App that makes it run on the full decentralized blockchain features which avails it of required high security of tokens in its protocol.
- Participation in Governance issues: Holders of the tokens which is see as liquidity providers are known to have the privileged to participate in governance and issues relating to the any change or development of the ecosystem.
- There is efficiency and flexibility of assets across platform seen in yield farming at will but for purposes of earning more and reduction of transaction fees.
**Disadvantages**
- Since most of this DApps are built on the Ethereum Blockchain, what do we expect. There are high transaction fees (Gas fees) seen in the ecosystem which may likely reduce the active participation of some low crypto users.
- Issues of Impermanent Loss: Just as discussed earlier, this simply means the price devaluation seen in an asset added in a pool vis-a-vis the initial value when it was added. When asset is removed, it is known to be permanent loss this time.
- Forced Liquidation: Due to the price devaluation and market volatility effects, Loan To Value ratio is seen to be affected and loan liquidated. This causes disjointed process and repayment for the user
>10.Conclusion
The DeFi has continue evolved in the cryptocurrency space by providing platforms for buyers and sellers who transact and exchange assets without having to pass through the conventional intermediaries. It has brought transaction to the freedom of all bearing in mind the no documentation rigorous process during on-boarding, high security features that guarantees safety of assets and access to use at will with ownership of account assured.
The Yield farming which is an improvement from the DeFi is an additional passive income avenue for the user who thins the best way of maximizing profits by utilizing its idle assets is by locking them up in a pool and get them lent out to borrowers. So far this concept has evolved and now present in so many exchanges for users to farm and provide liquidity which in turn earn reward from trading fees charged from borrowers of this liquidity.
Thank you Prof @stream4u.
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