Crypto Academy / Season 3 / Week 4 - Homework Post for Prof @stream4u

Hello Steemians. This is my submission post for yet another homework task. This week Prof @stream4u presents a valuable insight into CeFi, DeFi and Yield Farming. So here's my task.....

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1. What Is the Importance Of the DeFi System?

In the contemporary day-to-day affairs, our financial resources are being regulated by a central authority, for e.g. banks, fund organisations etc. Although we deposit money in such Centralized Finance (CeFi) systems, we don’t have the final say in how our money is being circulated and utilised. If these regulating bodies make huge profits by investing our money, we don’t get any extra share of profit upon our money. Also there are huge risks involved in such a system if inflation hits the economy.

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That is the reason why the world is slowly trying to move towards a Decentralized Finance (DeFi) system. A DeFi set-up removes the existence of these mediator organs, like banks. What it does is connects buyers or borrowers with sellers or lenders over the blockchain platform through smart contracts. This will outroot the ‘hub and spoke’ model of finance in the modern world. Users can have enhanced control over their assets with wallets and exchanges. DeFi will simplify financial transcational activities like trading, investing, lending, wealth management due to the presence of a permissionless decentralised feature over the blockchain protocol.

Although these are still early days, but the DeFi revolution has been able to garner attention. With a proper digital infrastructure in place, we could be heading towards an era of ‘open finance’ very soon.

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2. Flaws in Centralized Finance.

• When we put fiat currency for saving, we earn a limited interest as specified by CeFi systems. However, these institutions keep moving our assets and invest them in appropriate areas to maximize their returns. But users won’t get any part of the surplus profit made by them. Thus users have no control over their own money.

• The CeFi system is a time consuming affair when it comes to withdrawals and deposists. Documentation and authentication of the transactions may delay the entire process and make it problematic for users.

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• Fund transfer in CeFi platforms may get delayed by hours or even days due to server problems, other reasons.

• For initiating CeFi accounts, the user needs to physically visit the institutions, process all the paper works and finally get an account ready for transactions. This is very laborious as opposed to DeFi systems where accounts can be created within seconds at the comfort of one’s own space without any outdoor visit.

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3. DeFi Products. (Explain any 2 Products in detail).

JustSwap:

^{Just Swap dApp interface integrated with TronLink wallet}

JustSwap is a decentralized exchange built on the TRON platform. It allows swapping of any two TRC20 token instantly taking into account prevailing price. Users can also stake tokens into its liquidity pool. In return, the trading fee collected by the system is paid to the asset lenders as rewards. JustSwap also offers instant execution of orders without having

Trust Wallet:

^{Trust Wallet mobile app interface and services}

It is the official crypto wallet of Binance. With the help of its mobile app users can trade numerous crypto assets safely. We can play blockchain games, even earn interests by staking tokens in liquidity pools and also access dApps and DeFi platforms. Trust wallet also supports in-house Uniswap and Pancake Swap trading. This makes Trust Wallet a popular DeFi product.

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4. Risk involved in DeFi.

• Risk of Price Volatility: When we take loan or borrow cryptos from liquidity mining pools, we need to add another crypto worth same value as collateral. This is a proof of authentication from the borrower’s end. If due to bearish market trend, the price of the crypto submitted as collateral falls, we need to add more of that crypto asset to balance the rates failing which our collateral may be liquidated.

• Risk during Swapping: This is a problem which I faced during my attempt to swap some tokens recently. Many popular decentralized exchanges allows listing of tokens without any authorisation. As such there are a lot of scam tokens which have names similar to some big and established crypto assets. While swapping a specific token for an established reputed token, users often select those scam tokens with similar name and symbol, thus losing funds in the process.

• Risk of Rug-Pulls: In this process, tech developers create a token pair, often pairing a new token with a high valued token and promote yield farming. When enough asset is deposited in the liquidity pool, the developers use the back door and sell the newly promoted token for the high valued token and finally disappear. This leaves a huge volume of the new token valueless.

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5. What is Yield Farming?

Yield Farming is a process by which we can earn cryptos by choosing to lend out cryptos to borrowers. In this system, lenders and borrowers are bound together by a mutual agreement known as smart contracts. After the specified time period, lenders earn interest on their assets which they have staked in the platform’s liquidity pool.

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The amount of profit in yield farming varies from network to network. Farmers explore different strategies to maximize their returns. Strategies are largely kept confidential because the more it is explored, the higher will be the user base and returns will be minimized.

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6. How does Yield Farming Work?

In yield farming, users are rewarded with cryptos on their cryptos. This is similar to the traditional banking operation of lending-borrowing where lender earns interest, but here it is a decentralized mechanism to the core. As such, the user who lends the crypto assets is the bank itself, thereby earning larger rewards.

Yield Farming – the process:
Initially, the user stakes his crypto assets in the liquidity pool, i.e. he’s sowing his surplus assets in the crypto farm. Now when a trader borrows or buys assets from the liquidity pool, he pays transaction fees to the network. Part of this fee is paid to the Liquidity provider or lender, i.e. he now reaps rewards from the farm. This is yield farming.

7. What Are the best Yield Farming Platforms and why they are best. (Explain any 2 in detail)

Uniswap:
This is an ethereum-based decentralized crypto exchange. We can swap platform compatible tokens as well as stake in liquidity mining pools, thereby encouraging yield farming.

Lenders who provide liquidity to the system earn a part of the interest generated in the process. This is paid in terms of UNIswap Liquidity Provider (UNI LP) tokens. In this way, users can track their contribution to the liquidity pool as the tokens keep accumulating. Further they can be put up as collateral for getting a loan sanctioned from Uniswap.

Many dApps have now integrated their systems to give users a hassle free access to Uniswap. In terms of total asset valuation locked, Uniswap is among the top exchanges, another reason for its popularity.

Pancake Swap:
This is another big name in the DeFi platform which is based on the Binance Smart Chain network which is EVM (Ethereum Virtual Machine) compatible, thereby allowing interoperations between ETH and ERC tokens.

Pancake Swap allows token swaps, staking in pools and in-house gambling platforms.

BSC is a much faster network than ETH networks, which allows Pancake Swap operations to take place quicker.

Also transaction fee is comparatively lesser over this network which has attracted a large user base to this dApp which also offers its native token CAKE to its users for Liquidity pool staking.

8. The Calculation method in Yield Farming Returns.

The calculation of interest in Yield Farming is done in two ways, as follows –

APR (Annual Percentage Rate):
In this method, the interest payable to the lender is calculated using Simple Interest. Let us understand with an example.

Suppose, we see an offer for investment where they are giving an APR of 100%. Often we become curious to know how much profit will we make after investing for a year. (same is the case with me)

Let’s say we invest $ 100 for a year at an APR of 100%.

Here, Principal (P) = $ 100
Time (n) = 1 year
Rate (r) = 100%

Therefore,
Simple Interest (S.I.) = (P x n x r)/100
= (100 x 1 x 100)/100
= $ 100

So, we will earn $ 100 in interest.

We know,
Amount (A) = Principal (P) + Interest (I)
= $ 100 + $ 100
= $ 200

So, the Annual Percentage Rate (APR) is $ 100.

Now let’s move to the second method of interest calculation in yield farming.

APY (Annual Percentage Yield):
In case of APY, the yield is calculated based on compound interest. Let’s understand this case also with a calculation.

Suppose, there is an offer for investment with returns of APY at 100% . So how much will we make in profit at the end of a year if we put in $ 100 investment.

Here, Principal (P) = $ 100

Compounding period (n) = daily = 365 days
Rate (r) = 100 %
Time (t) = 1 year

Therefore,
Amount (A) = P(1+r/n)^nt
= 100 x (1+1/365)^365 x 1
= 100 x (366/365)^365
= 100 x (1.0027)^365
= 100 x 2.675
= 267.5

So, we earn interest = $ (267.5 – 200) = $ 167.5

Hence the Annual Percentage Yield is $ 167.5.

9. Advantages & Disadvantages Of Yield Farming.

Advantages:

• We can invest our crypto assets for a long term and make extra income instead of them lying idle in our wallets and generating nothing.

• This method is more rewarding than fixed deposits in CeFi systems. Higher rewards attract more users to the decentralized platform.

• There is no need of any identity verification. Anybody with crypto tokens can be a part of yield farming and reap rewards in the long run.

Disadvantages:

• Investors may suffer losses due to price volatility if the market price of the crypto token supplied to the yield farming pool drops. In such cases, they may not be able to recover their original amount.

• Despite all the technological advancements, there are still cases of cyber crimes, digital fraudulent activities etc. all around us. So, there is no guarantee that the smart contracts in DeFi systems cannot be altered. This may result in pilferage of funds, data leaks etc.

• With the introduction of newer yield farming pools, the return rate on investment gradually decreases on the existing pools. As such, investors profit percentage is significantly reduced.

10. Conclusion on DeFi & Yield Farming.

DeFi is a relatively new concept for majority of the global population. It has endless possibilities in the modern world where internet is lifeline. DeFi can address the short comings of the traditional financial systems and usher a new era of open finance.

With crypto assets gaining popularity over blockchain networks, users can earn back cryptos by choosing to loan out surplus stock in what is being termed as yield farming, where we sow cryptos and harvest cryptos in the farm. I thank Prof. @stream4u for presenting this awesome lecture this week and making us more aware of the crypto universe.