Crypto Academy | Season 3 | Week 4 - [Homework Post for Professor @stream4u]
Lets head on towards the questions
1
What Is the Importance Of the DeFi System?
The Decentralised financial system commonly known as DeFi is a system in which there are no third parties involved.
For example in a centralised financial system you have banl accounts where the banking systems are involved and you have to work on the policies set by a centralised system.
In DeFi the assets or tokens are available on a blockchain network which can be accessed by any user on that blockchain.
There are different protocols and technologies used which bring about this decentralised system. One more feature of the DeFi are the smart contracts which help in the automated regulation of agreements between traders.
DeFi has already made it's mark in the financial world. It provides us with various new opportunities through which we can earn. It has offered us innovative ways of borrowing lending or even trading money. Furthermore the most important element of not involving any intermediary or a third party is also very important which we get through DeFi.
Borrowing and Lending in DeFi
Through DeFi traders have the opportunity of having a P2P lending and borrowing platforms which have their smart contracts and have absolute security which also make sure that there are no third parties involved. On these decentralised platforms, users can lend their assets to the lending pools where other users can borrow them. Through the lending process, the lenders can earn through interests. One example of a lending platform is Justlend.com
Yield Farming
Yield Farming on DeFi is basically your savings which you lock in the lending protocols to get profits through interest from the trading fees. Users can also gain additional profits through the particular Protocol's Governance token.
DeFi Marketplaces
The defi marketplaces have also changed the exchange system to a considerable extent. Now we have decentralised exchange (DEX) on thich we can have P2P exchange of assets
One example of such platform is the uniswap
So we see DeFi has enhanced the trading and the financial system. There are further important factors, such as;
Transparency it provides is also very important. The transparency in DeFi is provided as the information of all the tasks carried out on a blockchain is shared with every user on it. You can easily see the transactions or any other data. So there are very less chances of frauds or hacks in a Decentralised financial system.
Security through the encryption of blocks and various other security protocols which are taken on the decentralised finance system, such as recording the data of transactions. All these security measures help in securing the DeFi against frauds and hacks.
Confidentiality is provided in DeFi in such a way that Users are not required to give in their personal details or information while having transactions
No involvement of Intermediaries
As we all know the main motive of having a decentralised finance system was to overcome the obstacles we have in centralized financial system, such as involvement of Intermediaries like banks and governments. In DeFi we overcome this system and have direct P2P network.
The importance of DeFi system was discussed in detail with every aspect in this question. Hope its clear to you all
2
Flaws in Centralized Finance.
The CeFi or the centralised finance system has it goods and bads. But it was due to some Fundamental Flaws a DeFi system was required. In this question we will discuss what those Flaws actually are.
a) A Delayed Process
We are all aware of the centralised banking system in our countries where there is slow decision makings by the personnels which lead to slow processing of transactions.
b) Lack Of Transparency
In a CeFi the authority is within a central committee or a person through whivh all orders are followed. For example if the personnels in a centralised financial system get an order from their bosses, they cannot deny from that order no matter if that order is based on facts and figures or not.
c) Security
There's comparatively less security in CeFi than DeFi. For instance, f you've your money in a centralised banking system and it goes bankrupt, you will also lose your funds and then there's nothing you could do about it. Even in my country there have been several cases of this sort where People lost their money.
d) Involvement of Intermediaries
A Centralised Financial System has intermediaries involved. So there is a huge impact of personals' mood and their behaviour on the financial system. You also need to stand in long lines in banks waiting for your transactions. Also, you will have to wait for days while sending money from your country to any other. One such example I will give of my own. I used to live in Saudi Arabia and when we used to send money back to Pakistan, it used to get quite hectic for my family to receive it here. Furthermore, high fees are also deducted.
The flaws of a CeFi were thoroughly discussed in this question. Hope its clear to you all
PS: after these two questions I'll compare DeFi and Cefi then proceed to the next question.
| DeFi | CeFi |
|---|---|
| Your money is possessed by you | your money is possessed by the company |
| Transactions take place in very little time | Payments can take up to days |
| Open to everyone | a person has to first apply to that specific Financial Service |
| 24/7 Market availability | Markets are closed |
| Transparent. You can see the transactions history data etc | Not Transparent. The data and history etc is hidden. |
3
DeFi Products. (Explain any 2 Products in detail).
There are multiple DeFi products which have helped their users alot. I'll be discussing two of them in the answer below.
a) Decentralised Exchange(DEX)
In a decentralised exhange users can swap their assets via a P2P decentralised services. The assets could be swapped from the liquidity pool.
The DEXs are non custodial and built on smart contracts and it make sure there are no intermediaries involved between the traders.
The DEX cannot access any user's assets or any information related to the users.
There are On-Chain and Off-Chain Order books. In the On-chain order books there are nodes which record the data related to all the orders that have taken place. The transactions are also confirmed by the miners
In Off-Chain Order books, the records of the transactions are arranged in a centralised entity.
Furthermore the usage of Automated Market Maker (AMM) in the Decentralised Exchange platforms, which utilize smart contracts to create liquidity pools theough which transactions are automatically completed if they follow the set of criteria. The AMM is used by multiple exchanges such as Uniswap, Kyber network etc
If for example there's a disagreement between two traders, there's an Arbitrator who settles this disagreement between the users.
Moreover, DEX as less prone to the hacks and frauds. The users of DEXs can buy and sell using their hot and cold wallets due to that they do not have to use their private keys as well.
You can use Decentralised exhanges by signing up on them and then linking a Decentralised wallet such as Trustwallet
Examples of DEXs are: Uniswap, pancakeswap etc.
b) Decentralised Wallets
A Defi Wallet is a non-custodial Decentralised wallet in which you have complete authority on your wallet. You have complete ownership on your assets of which you can store send or receive assets.
It's well protected with a unique Key. There is a 12-word seedphrase ehich the owner has to keep safe. The Defi wallet is extremely secured. The recovery phrase should be kept ver safely as if you lose it you will not be able to recover it.
There's usually a transaction fee on these wallets as the transactions are on-chain which have a waiting time for the transactions to be confirmed.
These DeFi wallets are basically very hard to hack.
There are two types of wallets
a) Cold Wallets: These wallets remain offline therefore very less chances of hacking.
b) Hot Wallets: These type of wallets remain online.
There is also swap options in wallets. Through this option you can swao your assets which comes in very handy.
Examples: Exodus Mycelium etc.
Characteristics Of DeFi Wallets
They are used to secure assets
Used for long time storage of assets.
you have complete autonomy over your assets
- if you forget your Private key you will lose all your funds
- Convenient for Long-term storage of assets
Two DeFi products, ie, Exchanges and wallets were thoroughly discussed. Hope its clear to you all
4
Risk involved in DeFi.
In this question I'll discuss risks involved with DeFi
Price Volatility
There's constant fluctuations in the price of assets. One moment you're in profit, the next moment you might face a big loss. This does not happen in a Centralised Financial System.
Scalability
Scalability is one of the major risks/problems as well. Blockchains which have low scalability result in long period of time for transactions to take place and transactions arr expensive as well
Unpredictability
When a Defi blockchain which is unstable there is bound to have instability. Sometimes when some blockchains change their consensus algorithms such as chainging from PoW to PoS (eg: Ethereum) it makes it risky.
Smart Contracts Risks
Smart Contracts no doubt a good thing in the DeFi projects but if there's even minor issues in any code of the Contract, it could put your funds at risk.
No Interworking
There are different DeFi projects which work on their own blockchains and have interoperability. Through this different communities can interact with each other. Interoperability in the DeFi has been complicated.
Insufficient Insurance
When there's insurance on anything we get a sigh of relief. In DeFi there's very little insurance and if you lose funds you will not get them back
Centralization within DeFi
No matter how absurd it may sound but its true.
“Sushiswap” was a DeFi project. The anonymous founder of Sushiswap has rug pulled the project converting all of his Sushi tokens to ETH on September 5, 2020. The price of SUSHI token went up in value to $10 after forked from the Uniswap protocol, and dropped to 0.6$ (at the time of writing this article) after founder converted his tokens. This was an example of how a single point of failure is possible even within DeFi.source
Risks involved with DeFi were thoroughly discussed. Hope its clear to you all
5
What is Yield Farming?
Yield Farming
Yield Farming is a way of earning rewards. This happens when you hold your Crypto assets, you receive rewards for it.
There are liquidity pools available, in which you can lend your assets to the pool and you will earn interest from the trading trading fees of that pool. Other than that some lenders are also given rewards in the form of additional yields by the particular Protocol's Governance token.
It works similar to the traditional bank loan system. For example you take a loan from the bank and when you return it you will have to pay the loan back with interests. In Yield farming you get interest in the form of tokens.
The yielding awards are in terms of Annual Percentage Rate (APR) and Annual Percentage Yield (APY)
6
.> How does Yield Farming Work?
Yield Farming works with the help of Liquidity Providers and a Liquidity Pools in a DeFi market.
Liquidity Provider: the Liquidity Provider is the user who deposits his assets in the Liquidity Pool.
Liquidity Pool: This is a smart contract which is filled with funds deposited by the Liquidity Provider.
The Yield farming works on the basis of Automated Market Maker (AMM) which creates a Liquidity Pool with the help of smart contracts. These pools implement the trades determined on pre decided algorithms. In this way the traditional order book is overcome.
When the lenders deposit their funds in the Liquidity Pools, they get interest in the form of yield tokens. As mentioned this is like the bank loan system where when you return loan you have to pay an interest as well.
Yield Farming and its working was thoroughly discussed. Hope its clear to you all
7
What Are the best Yield Farming Platforms and why they are best. (Explain any 2 in detail)
a) PANCAKESWAP
PancakeSwap site is a decentralised exchange which works using the Binance Smart Chain. On PancakeSwap there are liquidity pools which work through the automated market maker.
The PancakeSwap is used for the exchange of the BEP-20 Token
On PancakeSwap you can do Yield farming, stake your coins and earn interests.
PancakeSwap has the following features to our benefits:
- You can Provide liquidity to the exchange and earn profits.
- Stake your asset to earn Cake token
- Then stake Cake to earn more cake.
- Trade BEP-20 Token
Advantages of PancakeSwap
Low Fees
PancakeSwap uses the BSC network with it BEP-20 token. It's fees is way less to the projects built on Ethereum. The fees on PancakeSwap varies from $0.04-$0.20 as compared to $20 on Ethereum.
Fast Transactions
The transaction time on PancakeSwap is also way faster than that compared to Ethereum. On PancakeSwap transactions can take place within 5 seconds compared to Ethereum which take place in 5 minutes.
Secured
PancakeSwap has a contract with the Cyber security company CERTIK
On PancakeSwap, investors can earn upto 250% APR on staking their assets.
It has a liquidity of $3.59B with a 24Hr volume of $508.51M which is massive
The PancakeSwap top tokens and top pools are also demonstrated.
b) UNISWAP
Uniswap is a decentralised exchange which runs on the Ethereum blockchain. On Uniswap the Liquidity Pools which work on the Automated Liquidity Protocol which doesn't require any intermediaries and focuses on complete decentralisation.
On Uniswap you can swap the ERC-20 Token and also earn rewards through staking, yield farming etc.
Uniswap has over $5B locked in its smart contracts. Furthermore it is completely open-source that means any user can copy its codebase to create a same DeFi protocol.
As mentioned the Uniswap has the AMM which allows the swap of ERC-20 TOKEN without having a need to find any buyer or seller
Traders can earn profits upto 50% APR for staking their assets.
8
The Calculation method in Yield Farming Returns.
The profits earned in the Yield Farming can be calculated by two methods
a) Annual Percentage Rate (APR)
The Annual Percentage Rate is the interest paid to the user who has locked in his assets in yeild farming. This does not take compound profit in account.
For example if a trader has staked tokens worth $100 with an APR of 80% per year. He'll recieve $180 at the end of the year where he'll get $80 as an interest reward with $0.21 per day.
b) Annual Percentage Yield
The annual percentage yield is tsken from the borrowers in the Liquidity pools and then given to the lenders. In APY you get a compound interest.
For example you staked tokes worth $100 with an APY of 80%
If we use the (1+r/n)^n-1
Where
r = period rate
n = number of compounding periods
So;
- (1+ 80%/365)^365-1
- (1+0.8/365)^365-1
- ( 1+0.0021917)^365-1
- (1.00211917)^365-1
- (2.223) - 1 = 1.22
- APY = 1.22 x 100 = $122
-The total investment after the year would be:
Initial Investment + APY:
100 + 122 = $222
The total return on investing $100 after one year is = $222
Note: As I talked to the professor in the comment section of the lecture, there can also be losses in APR and APY as a loss in liquidity
9
Advantages & Disadvantages Of Yield Farming.
No matter anything which may have many benefits it also has some disadvantages. I'll discuss advantages and disadvantages of Yield farming in this question.
a) Higher Profits
Yield Farming gives us high rewards than traditional bank loan system. We can get upto 80% profits.
b) Annual Percentage Yield
As we have seen in Annual Percentage Yield we get high interest profits. It is comprised of the compounding interest
In yield Farming we can also turbo-charge our returns with liquidity mining. We receive tokens from the entity borrowing their assets in addition to the high interest on their loans
Disadvantages
a) Impermanent Loss
There's a lot of volatility in the market. So if the price of an asset falls, the locked funds are affected.
b) Smart Contracts
Any change in the nodes of a smart contract can affect the funds on that smart Contract.
c) Liquidation Loss
Im DeFi exchanges the liquidity is provided by the traders. If the value of the collateral drops below the loan's price it could cause problems.
For example in a pair of LTC/TRX is the price of LTC suddenly rises it will have a collateral affect on the loan against the TRX
Finally this mammoth of assignment post comes to an end. In this assignment now we have a clear idea of the DeFi.
DeFi is indeed a better system than the CeFi as it provides autonomy to the users.
There are multiple projects of the DeFi such as the Decentralised Exchanges, decentralised wallets etc.
In the DEXs we can earn through yield farming, staking and lending. We get yearly profits in yield farming which can be calculated through APR and APY
It is as simple as it gets in which you get profits only by locking in your assets. Lenders also get profits from the liquidity pools as tokens from the trading fees.
But there are also some risks involved with the DeFi such as Impermanent loss and scalability issues.
All in all, DeFi is the future and I believe a perfect alternative to the Centralised Financial System.
Thank you professor @stream4u for this lecture. I enjoyed making it hope you had a good read as well
Regards
@huzaifanaveed1
Hi @huzaifanaveed1
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@stream4u
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