DEFI: UniSwap - ALL YOU NEED TO KNOW 🦄Hi Traders, Investors and Speculators of the Charts 📈📉
If you’ve been following me on TradingView for a while, you’ll now that I’m a believer – a believer in the promise of blockchain. One of the principals of this promise is to move away from centrally controlled banking systems. This would eventually include the act of saving and earning interest for the money that you leave in the capable hands of your banker (who also gets to decide whether or not you qualify for loans). Currently, you need to give up all of your personal information to open a bank account and furthermore you are seriously undercut in the returns / interest rate that you will be receiving (to name only two of many problems with the system). For example, where I reside, the most common interest on a savings account is 5% annually, whereas the interest on your credit card is 19.5% annually. And this is, in short, the common argument for Decentralized Finance.
Before we continue, familiarize yourself with these key terms:
TVL – Total Dollar Value Locked in the platform
DEX - A decentralized exchange. DEXs don't allow for exchanges between fiat and crypto — instead, they exclusively trade cryptocurrency tokens for other cryptocurrency tokens.
Blockchain – A unique way of coding that is open for anyone to use, many believe that web3 will be built on top this kind of coding
DeFi – Decentralized Finance such as cryptocurrencies and stablecoins
dApp – Software like apps that work on the basis of blockchain code and thus apps that accommodate cryptocurrency such as UniSwap and NFT Market places
LP tokens - New liquidity pool tokens. LP tokens represent a crypto liquidity provider's share of a pool, and the crypto liquidity provider remains entirely in control of the token. For example, if you contribute $10 USD worth of assets to a Balancer pool that has a total worth of $100, you would receive 10% of that pool's LP tokens.
APY - Annual Percentage Yield, think of it as yearly interest in percentage
Smart Contracts — E lectronic, digital contracts coded to integrate with dApps. Automated financial agreements between two or more parties once the pre-determined terms of the contract is reached
Uniswap is a decentralized cryptocurrency exchange that uses a set of smart contracts (liquidity pools) to execute trades on its exchange. It's an open source project and falls into the category of a DeFi product (Decentralized finance) because it uses smart contracts to facilitate trades. Built on Ethereum, Uniswap is the first and largest DEX in DeFi and one of the many places where you can participate in yield farming. To earn interest in their cryptocurrency holdings, investors contribute their funds to a Uniswap smart contract; these investors are known as liquidity providers. The smart contracts that hold their cryptocurrencies are known as liquidity pools. Liquidity providers are required for Uniswap to function since they provide liquidity for trading on the platform.
With the rise of Blockchain, Crypto and then Decentralized apps, yield farming was born to address some of the banking system's limits. Or at least, that would be in the perfect world.
Yield farming is the process of using DeFi to maximize returns . Users lend or borrow crypto on a DeFi platform and earn cryptocurrency in return for their services. This works for both parties, because yield farmers provide liquidity to various token pairs and you earn rewards in cryptocurrencies. However, yield farming can be a risky practice due to price volatility , rug pulls, smart contract hacks etc.
Yield farming allows investors to earn interest which is called ‘yield’ by putting coins or tokens in a dApp, which is an application (coded software) that integrates with blockchain code. Examples of dApps include crypto wallets, exchanges and many more. Yield farmers generally use decentralized exchanges (DEXs) to lend, borrow or stake coins to earn interest and speculate on price swings. Yield farming across DeFi is facilitated by smart contracts.
Let’s take a closer look at the different types of yield farming on UniSwap:
Liquidity provider: You deposit two coins to a DEX to provide trading liquidity. Exchanges charge a small fee to swap the two tokens which is paid to liquidity providers. This fee can sometimes be paid in new liquidity pool (LP) tokens.
Lending: Coin or token holders can lend crypto to borrowers through a smart contract and earn yield from interest paid on the loan.
Borrowing: Farmers can use one token as collateral and receive a loan of another. Users can then farm yield with the borrowed coins. This way, the farmer keeps their initial holding, which may increase in value over time, while also earning yield on their borrowed coins.
Staking: There are two forms of staking in the world of DeFi. The main form is on proof-of-stake blockchains, where a user is paid interest to pledge their tokens to the network to provide security. The second is to stake LP tokens earned from supplying a DEX with liquidity. This allows users to earn yield twice, as they are paid for supplying liquidity in LP tokens which they can then stake to earn more yield.
Yield farmers who want to increase their yield output can also use more complex tactics. For example, yield farmers can constantly shift their cryptos between multiple loan platforms to optimize their gains.
Back to DeFi - In centralized finance, your money is held by banks and corporations whose main goal is to make money. The financial system is full of third parties who facilitate money movement between parties, with each one charging fees for using their services. The idea behind DeFi was to create a system that cuts out these third parties, their fees and the time spent on all the interaction between them.
Defi is a technology built on top of blockchain - it can be an app or a website for example, which means that is was written in code language by software programmers. It lets users buy and sell virtual assets (like crypto and NFT's) and use financial services as a form of investment or financing without middlemen/banks. This means you can borrow , lend and invest - but without a centralized banking institution. In summary, DeFi is a subcategory within the broader crypto space. DeFi offers many of the services of the mainstream financial world but controlled by the masses instead of a central entity. And instead of your information being filed on paper and stored by a banker, your information is captured digitally and stored in a block with your permission. Many of the initial DeFi applications were built on Ethereum (which is a blockchain technology, but the code is different to Bitcoin's, in other words it operates/works differently). The majority of money in DeFi remains concentrated there.
Lending may have started it all, but DeFi applications now have many use cases, giving participants access to saving, investing, trading, market-making and more. Another example of such a market is PancakeSwap (CAKEUSDT). PancakeSwap is also a decentralized exchange native to BNB Chain (Binance chain). In other words, it shares some similarities with UniSwap in that users can swap their coins for other coins. The only difference is that PancakeSwap focuses on BEP20 tokens – a specific token standard developed by Binance. The BEP20 standard is essentially a checklist of functions new tokens must be able to perform in order to be compatible with the broader Binance ecosystem of dapps, wallets and other services.
💭 Final Thoughts 💭
Is yield farming profitable? Short answer - Yes. However, it depends on how much money and effort you’re willing to put into yield farming. Although certain high-risk strategies promise substantial returns, they generally require a thorough grasp of DeFi platforms, protocols and complicated investment chains to be most effective. Is yield farming risky? Short Answer - Absolutely . There are a number of risks that investors should understand before starting. Scams, hacks and losses due to volatility are not uncommon in the DeFi yield farming space. The first step for anyone wishing to use DeFi is to research the most trusted and tested platforms.
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