Intro

This is homework task of Crypto Academy Season 3 | Week 4 | Advanced course by crypto professor @stream4u on CeFi - DeFi - Yield. I have tried to cover all 10 requirement by the professor on the lecture while completing my homework.

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1. The Importance of the DeFi System

With the change of Technology, we can have the better options at our hand in many cases. Whenever we have better option at our hand, we try to update ourself with the best option. Centralized or traditional finance has some limitations and with the help of decentralized finance we can come out from those problems. Decentralized finance is one kind of finance which has almost all the features of centralized finance but the functions of middle man is being eliminated.

Decentralized finance is not working like traditional financial system rather it is making the financial products available to ultimate users through public blockchain network and usable by its users directly without any help of traditional middle man. It's a system software used by the blockchain network where financing related activities can be done directly. As all other facilities of financing is available but in smarter way without central control that's why it expected that decentralized finance will take over the traditional finance in the distant future. Some importance of Decentralized Finance (DeFi) is stated below-

• No middleman:
  We know in case of Banking transactions and financing systems we need to incur loss due to the banking channel. Bank borrows money from us and landed at higher interest rate. But from the spread, they are giving us a few. That's the problem and this is common in all other traditional financial systems where intermediaries are common.

• Modification:
  As it is based on a specific blockchain Technology then it can be modified or updated according to the requirement. In financial World, it is important to adapt with the change of the system and policies. It is very possible due to blockchain technology to make any change in the system.

• Authority and control:
  In DeFi system, there is no specific authority to impose some law rules and regulations on the money asset. A system has been developed with the blockchain Technology and that's why the control of the asset is on the hand of its users or owners. In Centralized Finance, the trader or investors are the owner of the money but they don't have control over their money when they deposit their money in the financial markets.

2. Flaws in centralized finance

What are the advantages I have discussed in previous question are the main disadvantages of the centralized finance (CeFi).

• Central authority and control over fund:
  Main feature of the centralized finance is the central authority who is issuing the money and have the control on the circulation of the money. According to their monetary policy they implement some policies to restrict or increase the flow of money circulation in the financial system. As the money is issued by the central authority and they are controlling the flow of the money then you can say that control and authority of the money is on the hand of a specific authority who is controlling the system.

• Risk:
  As the middleman is here, so it is not possible to get out of the risk. When someone is lending money to the bank he/she cannot be assured about his/her money back with interest. In the middle man part, there are always some risk involved in traditional financial system.

• Inflation and low return:
  As the inflation is not at our hand so the central authority should manage the inflation in case of money circulation and return calculation. But if the central authority failed to adjust the inflation with the interest, then it needs to be managed or adjusted by the investor that is another flaw of centralized finance. With the same time, we can have the experience of low return as middleman will charge it’s fee and after their profit they will distribute the profit to the depositors. There is a huge maintenance fee of a bank and other financial institution, and that is covered from the money or interest of depositors. Although the loan rate is high but still the depositors are not getting that much of money due to this middleman policy.

3. About two DeFi Products

a. Lending:

Same as banking transection, here people can invest in the lending part for the return on investment. Several interests are being provided by several product. Anyone can borrow as well from the lending pool by incurring specific interest rate. In this process, the borrower gives the interest and the lender is getting the interest in direct process. Smart contracts act as a mediator. Its is giving an opportunity to the asset holders to have some return in the form of passive income and opportunity to the borrowers as well to trade or use this asset for even higher return. This is almost similar process like centralized lending but without traditional middleman. Here, smart contract existed. Crypto loan is offered in lending of DeFi in a trustless manner without middleman called P2P lending. This lending also given to businesses and the lenders get interest in stable coins and cryptos.

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I have googled for some DeFi lending and found a website where several listed DeFi Lening sites are available.

I am sharing something about of those-

88mph

88mph is a Defi lending site which allows its users to lend their crypto assets at fixed interest rate and floating rate as well. In the picture you can see the dashboard of the page where a number of assets are available to lend at fixed interest rate. In the pool anyone can invest by watching the features like Total Deposit amount, Fixed APY, mph currency APY and other related values. All information has been specified in the website. Return will be given in MPH coin. According to available options, by connecting wallet anyone can lend some crypto for fixed or variable return and they can borrow form any pool as well.

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b. Decentralized Exchange (DEX):

Here exchange operation like buy, sell, swap etc. can be done with mentioned coin for specific time without any third-party involvement. In DEX, users have full control of his/her transection. Assets can be swapped with P2P service form liquidity pool. Between the traders, there is no intermediaries, this is prime feature of DEX.

Automated Market Maker (AMM) is used by many exchanges. AMM is used to create liquidity pool under smart contract for automatic transection. In case of any disagreement between traders, Arbitrator settle the issue. DEX can be used with Decentralized wallet. Common examples of DEX are Uniswap, PancakeSwap, JustSwap, Kyber network and many more.

4. Risk involved in DeFi

• Technical Risks:
  This arises from issues with protocols, hardware, and software. This kind of risk depends on some factors like race conditions, API, use cases and exception handling, and memory safety. Race condition generally results in making the sequence responsible for the outcome of an event unreachable.
  Memory safety risks causes memory interruptions, access errors, uninitialized variables, and memory risks. Lack of proper testing can also hamper in operation.

• Financial Risks:
  The decentralized blockchain has to be made with expert so that its users don’t incur much loss. Good knowledge on the financial tool by the DeFi developers is needed as we know its not a joke at all. In case of traditional financial market, or government financial system, experts are working continuously for the system. But here a decentralized system is being developed on which basis the trade/ transection will happen. So, its needs to be well analyzed. If it is not then risk is always associated.

• Volatility in Price: It’s a common nature in the crypto market where we can experience 50% price change over week. This risk is involved here. Gain today may be loss tomorrow.

• Liquidity Risk: As the liquidity is less in DeFi than it can lead extra transection fee in the system.

• Smart Contract Risk: Smart contract is based on preset code. If there were any minor error in the code, then customers can lose their fund because there is not central authority to give back the fund.

• Scalability Risk: In blockchain the transection per second is preset. So, adopting with technology and update its problematic.

• Insurance Risk: Fault or mistake by any parties can lead in fund loss. When fund is lost its lost forever as its not insured.

5. Yield Farming

This is another method of earning passive income from DeFi when you have unused asset at your wallet. Yield farming is a process which allows the holders of crypto to get some reward based on their holdings. Here the crypto holders deposit a certain amount of their holding crypto into a lending protocol to earn interest from trading fees.

Anyone can stake this asset in the liquidity pool to get return for their staking support to the DeFi. Exchange fees are given from the liquidity pool to the stake holders in (APY or APR)

6. How does Yield Farming Work

There are two components of Yield Farming has to be discussed to know more about its process.

• Liquidity providers are the holders of crypto assets who deposits the assets into the liquidity pool of the DeFi market so that that the transections can be easily done in the DeFi market. From the transection fees, the liquidity providers get the return.
• Liquidity Pool is the contract and this fund is filled with the fund provided by liquidity providers. The fund from this pool is used in the P2P transections to be executed. Thus, the transection fees generate which will be the profit of liquidity providers.

Order book like Traditional exchange is not required here in case of smart contract. AMM system here creates a Liquidity Pool and works on pre-established algorithm. Who lend fund in the liquidity pool, gets the reward according to their staking contribution. In next question answer, i am showing some screenshot of uniswap which can be helpful to know about the physical process of how to do this.

7. Two best Yield Farming Platforms

a. Uniswap

Uniswap is mostly popular decentralized exchange platform. It is a protocol on Ethereum mostly for the swap between ERC20 Tokens. Its not taking fee like the exchanges rather it is functioning as a public good where the users can trade token without fees and middleman. Some advantages of UNISWAP

Uniswap Features

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Swap option between two ERC-20 Token

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Connecting the wallet

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Pool features

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Overview

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Adding Liquidity

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Swap between UNI and ETH for example

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• Simple to exchange ERC-20 tokens
• No need to find buyer and seller for exchange or swap
• No Intermediaries
• Interface is good and huge data to analyze in the application
• At least five wallets can be added like Metamask
• Instant swap
• Allows to deposit fund from ETH wallet directly
• Trading fee is just 0.3% whatever the trading volume, trade size no matter.
• Complete Decentralization
• Open source
• APR is high for staking into Liquidity pool

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a. Pancakeswap

Pancakeswap is another popular swap based defi exchange (DEX) where yield is more and a number of options for swap is available. It has options to buy, sell, swap and exchange of BEP-20 (BSC) tokens. Passive income through offering liquidity is one of the main function of it and APR is so good compared with other. Now a days its popular among traders. Some reasons behind being best on my eyes-

• Variations of liquidity pool available
• Its token CAKE is in top 15 list of crypto
• AMM technology is used for price quotation. So no middleman.
• Trading of BEP-20 Token so easily
• Fee is low and varies between 0.04$ and 0.20$ only
• Quick transection takes only 5 seconds
• APR is very high and varieties of pool available for staking.

Overveiw pancakeswap

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High APR on several pool

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Many available pool.

8. The Calculation method in Yield Farming Returns

Two methods are used to calculate Yield farming Return. One is Simple interest based another one is compounding interest base (reinvested on daily basis).
Name of these two are-

• APR (Annual Percentage Rate)
• APY (Annual Percentage Yield).

APR means the total return on investment after a year in simple interest basis. It’s pretty simple interest calculation technique we use in our day-to-day life like return on investment in percentage of the year.

APR Calculation System

APR = (Annual Return / Investment) * 100%
For example, APR for CAKE token is 50% in the Manual Cake pool of Pancakeswap yield farming. If I stake $1000 then I shall have 50% of $1000 = $500 as a reward.
My total investment asset at the end of the year will be $1000+$500 = $1500

APY means the compounding interest. Here the reward of daily (if daily compounding) assets will be again used as investment for reward generation.

APY Calculation System

Lets consider Previous example again just changing the term APR into APY.
Formula, FV = Invested Amount * {(1+r)^n-1}\

Here rate, r = 50% = 0.5 yearly.
So daily r = 0.5/365 = 0.00136986

Time, n = 365 days

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So, according to formula,
FV = $1000 * [{(1+0.00136986)^365}-1]
= $1000 * {(1.00136986)^365 -1}
= $1000 * 0.64815725
= $648.16
Therefore, total return at the end of the year = $1000 + $648.16 = $1648.16

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Here you can see the difference between simple interest calculation and compounding interest calculation. With same rate, investment and time frame, one is $1500 and another is $1648.16. The difference $148.16 is the because of daily compounding.

9. Advantages & Disadvantages of Yield Farming

Advantages:

Passive Earning: The main objective of yield farming is the passive earning. Those who have some stake of coin, can get the benefit of staking and earning passive income without any work. They need to invest in liquidity pool, that’s it. Thus, will get annual return.

High Profit: Profitability is very high compared with any of the traditional investment alternatives. Sometimes we can see 50% APY which is the dream of real-life business or finance system.

Open for all to participate: Anyone can participate with any possible amount. Its not restricted for any user.

Can be compared with profitability: What is the return on any specific pool is given in the table. So, it’s easy to compare with other coins and traditional financing system yields.

Disadvantages:

Price volatility: The asset will be locked in the liquidity pool. In the meantime, price of that coin can be reduced in the market. So, it will incur more loss at the end of the year if cann’t be sold while price changing. Price volatility can affect in such many ways.

Ether Deposit: When we think about depositing ETH to the wallet, then its about withdraw gas fee. So, cost is not less in this case although swap gas fee is less.

Smart Contract: For any smart contract, if the node is not correct then it can cause problem to the users to lose their funds.

Liquidity Crisis: As the liquidity is provided by the investors in the market, then with the crisis of liquidity can lead to gas fee and price change.

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10. Conclusion on DeFi & Yield Farming

It’s a nice lecture on DeFi, CeFi and Yield Farming. I have learned a lot with the lecture and got some basic idea while completing the homework. It’s a tremendous way of learning which is very helpful to remember for the future life. I would like to thank @steemitcryptoacademy again for the initiative. I hope, I shall be able use my knowledge from this lecture in my future life. These topics DeFi, CeFi and yield farming are trending. Anyone traders of modern times should have basic idea on these three and this lecture cover the needs. Thank You.

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I am a lecturer of Textile Engineering and ex-banker. I love to share my thoughts and ideas through blogging so that anyone can be benefited from my effort. I write on Textiles, Online Money Making, Agriculture, Technology and random topics. Capturing Nature and Playing Cricket is my hobby. I am always a learner and wants to learn from all of you in this #steem community and chain.

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