Crypto Academy / Season 3 / Week 4 - Homework Post for @stream4u//Submitted By @meymeyshops//

Dear Prof @stream4u, I am delighted to have another opportunity to do this Season 3 week 4 task assigned to me. The lecture is understandable same as the many tasks. May you have the mindset you had at first which is to encourage students to succeed, while visiting this post.

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1). What Is the Importance Of the DeFi System?

Think of the roles that Centralized Finance have played and continue to play between savers of money and borrowers of fund in the world's financial space. When a saver deposits his hard-earned money in the centralized financial system, he hands off his control to the traditional bank. Even though it's obvious that depositors' funds are invested in stock markets and/or lend to borrowers, to yield great returns to the banks but a very little returns and/or interest is given to the depositors. What about how the commercial banks determine interest rates and collateral to the borrowers; their advisory role and providing markets for complex financial trades? Considering these how these roles are carried out by CeFi system brings to light the importance of DeFi System. Let's see them below:

+ Taking away the role of a custodian to savers of money

Decentralized Finance has its core importance in creating a permissionless system where transactions are free from the central authority but users are their own custodians with their private keys with no trusted third party.

+ Connecting the lender and the borrower devoid of intermediation

DeFi provides a system where unknown lenders and borrowers can transact business deals and determine their interest rates in relation to the prevailing demand and supply, and without any intermediary.

+ Making room for segmentation

Statistics from the World Bank shows that nearly 2 billion mature people worldwide do not have access to banking services but DeFi has come to bridge the gap because anybody anywhere with an internet enabled device is free to make use of DeFi user-friendly products at any time in spite of how little or much the user's fund is.

+ DeFi creates protocols that manages complex trades for users

They are designed products in DeFi ecosystem that serves as managers of assets for users by looking out for assets with high yield and perform such trades in behalf of the users. In this case, DeFi is challenging investment banks who offer advisory services and manages investors' account which usually attracts high investment cost. But in the case DeFi protocols, these products are cost effective and efficient, still the users are custodians of their accounts.

2). Flaws in Centralized Finance.

As we all know, the centralized Financial system manages all funds of users through its centralized exchanges who therefore have all control over the users' funds. In that case, the safety of users funds lies wholly in the hands of those exchanges and these users have to trust those exchanges for safe-keep of their funds. What are some of the major flaws bedeviling Centralized Finance? Let's look at them one after the other.

a). High interest rate to borrowers

Remember that in centralized system, the central bank after minting money lodge such fiat currencies to the centralized exchanges who then takes the mantle of lending money to borrowers at a very high interest. What happens to the huge difference between the monies given them and the ones lent out? The exchanges gulp down the difference (interest charged on borrowed fund). Centralized crypto exchanges works in similar way.

b). Uploading owners' private keys to exchanges

In centralized finance, participants' funds are out of their custody since they are demanded to release their security keys to the exchanges who are to trade and manage users' assets. This is very risky because if there happen to be any threat on the exchanges' website, users' security keys can be compromised.

c). High level of insecurity

Centralized platforms are often most vulnerable to attacks from hackers, that is why people often say regarding these platforms, that user's money is no longer their money because in any event of a hack, you lose your money.

d). High transaction fees and transparency issues

Due to the reason of the intermediaries existing in the centralized financial system, users often experience high charges to their trade. This is another drawback to CeFi as well as lack of transparency bedeviling the system.

e). Bottle-necked policies and regulations

The central authority is not very flexible but sometimes rigid in its policies and regulations, this has resulted in having millions of people globally, not being able to engage in formal business transactions with the centralized system.

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

Here I'll be discussing in detail two products of DeFi, they are
1). Stablecoins
2). Decentralized Exchanges

Stablecoins

After the evolution of Bitcoin, many hundreds of other cryptocurrencies evolved in the space too. Their prices are determined by supply and demand therefore they have high volatility. What this means is that their prices reacts to two extremes - higher and lower, with unpredictable stability. A holder of any one of these coins may be in high spirit this moment due to price increase but may become depressed within an hour as its price may crash to the wall. Is there any way out of such quagmire? Stablecoins is the answer. What are they and how do they perform. Let's read on.

Stablecoins are types of cryptocurrencies that are pegged at Dollar or in tangible assets such as gold and other precious pearls. These are coins that boost the trust of its holders in cryptocurrency investments since they reduce the volatility associated with price fluctuations other cryptos not in this class.

Methodology

Since Stablecoins are backed in dollar, that is they have fixed value therefore their prices do not often dangle compared to non-stablecoins. Examples of these stablecoins as DeFi products are MakerDao (DAI); TrueUSD; Paxos Standard (PAX); Gemini Dollar (GUSD); Steem Backed Dollar (SBD).

How do they manage to remain stable? The answer lies in the goal of the developers but most applies the principles of smart contract to stabilize their prices.

Steem Dollar is pegged at 1:1, this allows the coin to be more stable in value. It means that one steem dollar is equal to the number of steem coin that 1USD can purchase. Content creators in Steemit platform are protected from having the value of their rewards frequently fluctuated thereby boosting their confidence in making Steem Backed Dollar coin a medium of exchange and a store of value.

Stablecoins can be divided in three (3) categories namely:

• Collateral based Fiat: Every cryptocurrency that has a 1:1 ratio of USD falls into this category. This means for every one (1) crypto, one (1) USD is reserved as collateral.

• Collateral based Crypto: These types are not pegged at 1:1 ratio but at a higher rate to another crypto, reason being that since the cryptocurrency backing it is volatile therefore there must be higher number of such non-stablecoin to cover its volatile condition. For example, 100 stablecoin is backed at collateral for 200 ETH, that is 200% percent collateral value in case of price fluctuations.

• Non collateral: These ones have similar design to that of fiat currency in the sense that they are not backed by any form of collateral. How they works is that issuers or developers monitor their stability according to prevailing demand and supply. once they noticed that the price is above one (1) dollar, they issue more currencies to the market but if it goes down, they buy back the excess hence maintaining the coins stability.

Pros of Stablecoins

• It can be used as a means of payment devoid of intermediaries and it's cost effective and efficient in transaction.
• It has a higher probability of adoption by the public than non-stablecoins.

Cons of Stablecoins

• Minimal yield for investors
• A bit of fiat involvement regulation

Decentralized Exchanges

Unlike its counterpart - centralized exchanges - decentralized exchanges create a a market where buyers and sellers of cryptocurrencies thrive together in their transactions without the activities of any third party. Participants in these exchanges do not have to relinquish both their private keys and their crypto assets to the exchange authorities which action exposes users to risk of having their account keys compromised.

There are some categories of decentralized exchanges that performs their transaction with the use of order books either on-chain or off-chain. But fully powered decentralized exchanges do not look the way of order-books instead their trading activities are performed through Automated Market Makers (AMMs). They imbibe the principle of smart contracts that derives their transactions instantaneously. One good example of a Decentralized Exchanges is Loopring.

LoopRing: This decentralized exchange provides a trustless, non-intermediate trading facility for its users on Ethereum. It is an open source protocol that operates on zkRollup - zero knowledge transactions. Users do not have to provide their identity for verification before executing a trade on LoopRing. Cost of trading is very low.

Risk involved in DeFi.

They might be many risks associated with DeFi system but few are herein discussed accordingly:
1). Coding in Smart Contracts: The primary foundation of Decentralized Finance is Smart Contracts which are used to achieve similar functions of the centralized financial system. But the codes used in smart contracts to execute certain functions are often exposed to hackers or even very easy to decode making it possible for some bad eggs develop fake bots to perform illegitimate trades resulting in loss of users' funds.

2). Collateralization issues: While CeFi can effectively manage pressures on assets collateral arising from unforeseen crisis, DeFi may find it extremely difficult to adapt to crisis. This inability to manage pressures can result in constant price fluctuations and in some cases difficulty in accessing users' assets.

3). Irregulatory issues causing permanent loss of funds: Due to the fact that DeFi platforms are not being regulated by any central authority, the tendency of users being scammed by fraudsters are on the rise. In fact, one who losses plenty of funds to different scammers might not be able to stand up on his feet again.

4). *The high level of investment ventures executed on DeFi platforms often exposes it to attacks.

5). Scalability: As more and more influx of trading activities are executed on DeFi platforms, congestion gathers momentum. This will result in malfunctioning of applications as well as leading to some failing transactions and high transaction fees.

What is Yield Farming?

This is a process of using your crypto assets to earn more cryptos. How? Holders of cryptocurrencies no longer keep them idle or dormant, instead they provide them as liquidity to lending platforms who lend them to borrowers on interest. When such funds are returned with its interest accrued, the owners or depositors of such cryptocurrencies are given a share of the interest on top their capital. In a sense, they are earning passive income.

How does Yield Farming Work?

It works well with the lending platforms. Those platforms that provide lending and borrowing facilities to users, have what it is termed to be liquidity pool. That is a kind of reservoirs of funds into which holders of cryptos can add their specified amount to the lending platform's pool. From there, the platform provide borrowing or swapping of funds on interest, then at the end of the day, interests paid in are shared among liquidity providers according to their individual ratio. Again this process enables participants to accumulate tokens which otherwise may be hard to buy in large scale.

The possibility of such accumulation arose because fund raisers do not necessarily get back the crypto assets provided instead the distribution channel may generate new tokens as shares for providers or token swaps might be carried out resulting in distributing tokens other than the ones initially provided to the pool.

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

Among the best popular yield farming platforms, two (2) stands out and they are AAVE and MakerDao.

1). AAVE: Is a non-custodian DeFi platform that was founded as ETHLend but later changed to AAVE with the objective of serving her users a two-fold functions that made it an ardent competitor in the DeFi lending and borrowing space. Its objectives which are:

• to connect lenders and borrowers together through providing liquidity pool where users can add their cryptos to the pool to be lend out to borrowers and thereafter earn residual income arising from the interests distribution.
• to provide a pool where borrowers deposit collateral of different kinds and can swap such crypto to another choice tokens.

Note that liquidity provision is made by one investing his money in AAVE native aTokens which AAVE in turn put such funds to good use in order to yield profits little by little. AAVE also will lend such fund out to borrowers by collecting collateral in other cryptos.

How AAVE provides lending and borrowing

Borrowing is simple with AAVE, the user first deposits an asset as a collateral for the loan, then locate the Borrow icon, enter the amount he wish to borrow which must be comparable with the collateral deposited. He then choose his interest rate either stable or variable and confirm the process.

What makes AAVE the best yielding platform?

The attraction to AAVE is in its strategy of offering stable and variable interest rates which makes it stand out from its contemporaries. Stable interest rate is that fixed interest rate attached to a loan. This type of rate do not change as the market changes instead it remains fixed. This is good for investors because it enables them to make budget knowing how much interest to pay for a certain amount of loan.

Variable interest rate are types of rates that are affected by supply and demand in the market. This means that if prices of assets borrowed goes high, the interest rate moves up too and vice versa. The beauty of these two provisions is that a user is at liberty to switch between these two interest rates to suit his plan provided the user offset his transaction fees. Other platforms do not have such provisions.

Another upper hand AAVE have over its contemporaries is its offer of Flash Loans. These are short-term loans that do not require collateral for lending. It is an answer to speculators who leverage on this form of short-term loan, buy and sell assets withing the shortest of time and make profits no matter how little. But this Flash loans yield AAVE's native aToken to lenders' wallet in real time which are withdrawable instantly. No wonder the platform has notable market growth.

MakerDao

Like AAVE, MakerDao provides decentralized Apps for lending and borrowing of assets. A prominent and a pioneer in non-custodial DeFi lending and borrowing platforms. Volatility has been the problem of cryptocurrencies but MakerDao stepped in the way in 2015 under the auspices of a Danish developer Rune Christiansen, developed on Ethereum blockchain, to provide solution to price volatility. It does that by giving support to those volatile assets and help them stabilized.

Furthermore, MakerDao from inception aims at using the Ethereum smart contracts to permit users borrow funds against collateralized supported assets. What this means is that a user can take a loan by depositing ETH as a collateral and receive DAI. If the price of the ETH averages down, the maker protocol secured the collateral by selling it off. Whenever the loan is paid out, then the Maker token - DAI is completely burn up.

One notable reason why MakerDao is among the best DeFi platforms for yield farming is that, governance in the ecosystem is relinquished to Maker's governance token MRK holders. This style makes holders to be more active, and responsible who are also given incentives for taking part in governance.

Another edge to MakerDao is its use case of over-collaterlization methodology. In this case, since DAI is backed at 1:1 dollar, therefore to acquire one DAI, a user is expected to deposit much more than the actual amount supported crypto asset against DAI. Say your crypto asset to be deposited worth $50 equal to the amount of DAI to be borrowed, the Maker protocol expects the user to deposit at $80 asset. This is in case of the said asset dropped down below the amount loaned. If this happens, the protocol will sell off the asset to cover up the loan. But if the price remain same, then on pay back day, the borrower closes his debt position, unlock his collateralized asset and pay the interest accrued.

A quick glance at the procedure to use the user-friendly platform is shown on the image below. Having connected my metamask wallet, next is to make deposit of my collateral at the right side of the dashboard then confirm the process.

After entering the deposit, I opened my vault to see the divisions of processes involved. But this is just a trial not real.

The success of MakerDao makes it the best protocol. Think how much Ether is lock up in DAI smart contract (over 2%); and the debt issued out in DAI amount to over $77mm. The growth rate of DAI on monthly basis exceeds 20% and over 71% spenders of their DAI coin. All these put together ranked the platform among the best DeFis.

The Calculation method in Yield Farming Returns.

There are two ways to calculate Yield Farming Returns as shown below:
1). APR - Annual percentage rate
2). APY - Annual percentage yield.

APR focuses on the percentage rate alone without looking at the compounding rate of returns. This means that if the platform proposes an eighty percent return on investment annually, and a liquidity provider deposited $800 for instance. Therefore, at the end of the year, he will receive $800 plus additional 80% of $800.
800/1 x 80/100 = 800 + 640 = $1,440. This implies that the burden of the annual return rate is exerted on the borrower but paid to the capital investor.

APY takes into consideration the daily yield of the liquidity and plug it back to the pool in order to yield more profits. Therefore it makes use of compound interest.
If deposit is $800
daily yield is 0.12%
Annual percentage rate is 80%

Calculate daily yield by 360 days = 0.12 x 360 = $43.2
Add 80/100 (Annual yield) x $800 = 640 + 800 = $1,440

Total APY = $43.2 + $1,440 = $1,483.2

The implication here is that while the borrower bears the burden of return rate and paid to the capital provider, the daily compounding yield is paid to the investor.

Advantages & Disadvantages Of Yield Farming.

There is always the two sides of a coin - the bad and the good. So yield farming is not an exemption. Check the following :

Advantages

• Easy to get loan within seconds unlike the traditional banking where you would need to fill plenty of documents and wait for days or even months before a loan is granted.
• Users both lenders and borrowers are given chances to participate in governance in the liquidity pool.
• Liquidity providers get enormous returns on their cryptocurrency arising from high interest rates on their loan.
• The APY compounding the daily yield makes it possible for high profits for investors
• It is a good venture especially for the big whales

Disadvantages

• There is so much complexity with yield farming strategies. Some strategies that works today may become out-of-date tomorrow due to price volatility. Therefore there are risks associated with yield strategies.
• The likelihood of emptying the borrower's pocket to losses because of price volatility. If the price of the loan collateral drops so low than the price of the loan and vice versa, the borrower may have his account liquidated to pay off commissions.
• Risk involving the smart contract: The codes in smart contracts that take away third party (Intermediaries), can bugged by malicious hackers causing asset pricing to dip low and resulting in great losses to investors and borrowers.
• Increase in Gas fees: The more investors use the DeFi yield platform, the more gas fees increase hence the average investor won't be favoured. One statistics showed that at one time Gas fee jumped up more than 100 times resulting in liquidation of low income participants.

Conclusion on DeFi & Yield Farming.

From the beginning of this homework, one can deduce that DeFi is very important in the global financial system because of the many promising roles it plays. Ranging from giving custody of funds to the owners, removing the go-between personnel from lending and borrowing. The transparency of platforms offering trading services, creating segments that makes it possible for the unbank adults to gain access to these DeFi platforms with any internet enabled device. It seems DeFi is changing the way of the world's financial system. On the part of yield farming, research had shown that there is a great light on its path since all participants can leverage on yield farming. But it is imperative that participants must understand the merits and demerits inherent to yield farming before embarking on the venture. The average investor should know his risk aversion so as not to fall to impermanent loss of hard earned assets.

Thank you my Prof @stream4u for the wonderful opportunity of learning more from your tutelage. I remain yours student @meymeyshops.

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