Introduction
The world has been revolving from one financial system to the other it can be seen in the stone age where no physical means of exchange was used only trade by barter was a valid means of exchange with much advancement cowries and other precious substantial goods were used as means of exchange before the monetary system of using coins and cash were introduced this monetary system had their flaws which was users autonomy where the financial sector seems to be in charge of users funds and asset. with this limitation, an open-source decentralized financial system was introduced for users to control their funds without any third-party interference.
What Is the Importance Of the DeFi System?
Decentralized finance (DeFi) is the new monetary system that was introduced to counter flaws in centralized financial system here you are solely in control of your asset which gives you the major advantage to strategize how you would be holding or spending your holding below are some of the importance of DeFi system.
Transparency; an important aspect of the DeFi system is transparency where open-source blockchain technology can be used by everyone across the globe to make seamless transactions and also have access to transaction data of other users on the open blockchain explorer.
Counter third parties or middlemen; In a decentralized finance system a user need not worry about any middleman or third party before performing any transaction, with a peer-to-peer exchange service a user can connect to a blockchain network and conduct transactions like lending and borrowing of cryptocurrency.
Cross-border payment; with decentralized finance users can send and receive unlimited transactions across different countries without any boundaries.
Advance privacy and security; with a decentralized finance system users' choice of conducting transactions can be chosen they can decide to make their transaction go public or private also it gives users a chance to control their private keys.
Flaws in Centralized Finance
Centralized finance has its limitation that is opposed to the decentralized finance system.
Availability of middlemen; the use of third parties is one of the major flaws in centralized finance let's say I want to send money to another user in a different country I need to undergo a rigorous process before such transaction can be processed with these users find it difficult to make a seamless transaction.
Users autonomy; here before a user can make some huge amount of transactions he needs to do some paperwork on his money which gives users less authority over the control of their own money
Information and data; centralized finance needs to have access to one personal information and data before they can be able to have access to their account.
Restricted payment; in a centralized system, a user can be restricted from performing transactions to some part of the country due to some financial policies set out by government officials.
DeFi Products. (Explain any 2 Products in detail).
Wallets
The wallet is an important DeFi product that is used by users in the systems for making transactions among users it can be used for sending and receiving different kinds of cryptocurrencies.
There are different kinds of wallets a user can choose from hot storage wallet and cold storage wallet
The hot storage wallet is software that can be downloaded by users from the Apple play store or google which requires one to store/backup their phrase keys. Examples include trust wallet exodus wallet and more.
The cold storage wallet is a hard drive like a USB port they are more secure and can be accessed offline without an internet connection.
Importantly wallets are DeFi products used for making basic crypto transactions
Insurance
This is another DeFi product that allows users to take out policies on smart contract protocol decentralized applications.
Through smart contract protocols funds, assets and other cryptocurrencies can be reserved through pooled funds.
Examples of projects running this product protocol include Nexus Mutual, and, Opium Finance.
Risk involved in DeFi
Cost of gas fee in executing transactions; In a decentralized finance system ethereum gas fees in executing smart contract transactions are very high this has been a limitation in the DeFi system for users to complete executed orders.
Cyber theft; recently decentralized finance have been attacked where various user fund has been stolen by unknown hackers.
Smart contract vulnerability is also a major concern for the DeFi system as the dapps can be prone to cyber-attacks.Scamming/money laundering; there are lots of fake platforms claiming decentralization, where users have invested their hard-earned money and lost this money to companies claiming to be decentralized also money laundering, has been at an alarming rate with the inception of decentralized finance.
What is Yield Farming?
The idea behind yield farming is quite simple, here is a simple example suppose a crypto holder has a good amount of cryptocurrency in his wallet which sits idea every day expecting pump in the price instead of such cryptocurrency to sit ideal in one's wallet they can be put to use and generate some extra good income this is where the idea of yield farming comes in play.
Yield farming is a method/process that allows cryptocurrency holders to earn extra rewards on their crypto holdings.
A holder who serves as an investor deposits his crypto to a pool in the form of lending liquidity to the pool which generates a reward.
How does Yield Farming Work?
Yield farming works similarly as bank loans except in this scenario the crypto holder acts like the bank here the crypto holder loans his crypto to the liquidity pool by providing liquidity to the said pool as a loan which will be rewarded with interest from the platform trading fee as more users perform a transaction on the platform the crypto holder who is the loaner will be given a percentage from the pooled interest.
In contrast, yield farming works with liquidity providers ( crypto holders ), and a liquidity pool ( smart contract ).
What Are the best Yield Farming Platforms and why they are best. (Explain any 2 in detail)
Uniswap
Uniswap is a typical example of a yield farming platform that aims to eliminate the need for order books provided in crypto exchange platforms using automated market maker AMM.
It is also considered as one of the largest yield farming platforms that allow users to provide liquidity to the platform pool and in turn, earn interest.
*Why Uniswap is best"
Provide ERC20 token exchange; there are multiple ethereum based tokens today with Uniswap exchange users can be able to make a seamless exchange and buy any ERC20 token of their choice.
Large market shares; Uniswap is considered one of the largest liquid providers in the crypto space with over a 5.5billion assets locked up in its liquidity pool which means the platform is transparent and has gain users' trust.
Offers different fee tiers; Uniswap V3 offers users the opportunity to select different fee-paying systems which include 0.05%, 0.30%, and 1.00%.
Provide high APR; Uniswap provides users with 20% to 50% APR which makes it very lucrative for earning.
PancakeSwap
This platform is also a yield farming platform base on binance smart chain BSC unlike uniswap it allows users to provide liquidity base on binance token BNB.
Why PancakeSwap is best
Provides high APR; PancakeSwap provides users with 8%-250% APR this is a very high yield for users which makes the platform very attractive for investors.
Provide BSC base token; from the platform, users can have access to bsc base token and make an exchange easily.
The Calculation method in Yield Farming Returns.
In yield farming, we have two methods for calculating return Annual percentage rate APR and, Annual percentage yield APY
Annual percentage rate (APR) Calculation
Calculating return on this investment doesn't require the need for the investor to compound his earning base on daily return below is a simple method of calculating APR
Suppose I hold a crypto token worth $300 which I would like to deposit/provide as a liquidity token said the platform provides 100% APR on an annual basis it means by the end of the year I will be having a return of
100% of $300 = 1 × $300 = $300
By the end of the year, I will be having
My initial investment $300 + my APY $300 = $600
Annual percentage yield (APY) Calculation
To calculate APY one has to put compounding earning into consideration, it is the total annual return of one investment with compounding earning cumulatively added.
Suppose I used the same investment amount used in APR calculation
where interest r = 100%
Since its base annually I will be having 365 to lockup my fund n = 365
I will be using this formula to complete my calculation
( 1 + r/n )^n - 1
( 1 + 1/365 )^365 - 1
( 1 + 0.002740 )^365 - 1
(2.717) - 1 = 1.717
Computing the above value will result in 1.717 and my initial investment was $300
.Which will be 1.717 × $300 = $515.1 will be my annual APY.
My total investment after one year will be APR + APY = $300 + 515.1 = $815.1
Advantages & Disadvantages Of Yield Farming.
| Advantages | Disadvantages |
|---|---|
| Yield farming allows crypto holders to provide liquidity to pools and in return earn high yield returns | Locking up an asset for 365 days can be long term earning period which is not favorable to some investors. |
| Advantages | Disadvantages |
|---|---|
| Yield farming smart contract is open source which allows developers to work on improving the platform performance | Smart contracts are vulnerable to hacking which is a major target for hackers investors fund are at risk. |
| Advantages | Disadvantages |
|---|---|
| Yield farming platform like uniswap provides all ethereum base token for users which makes easy for users to have access to all ethereum based tokens | platform like uniswap don't offer another token aside ERC base token which makes investor look for an alternative platform where they can invest in other tokens. |
Conclusion on DeFi & Yield Farming.
Decentralized finance is for sure a game-changer in the financial sector as it gives users the freedom to control their funds without the need for intermediate parties it's an open-source system that allows users from different parts of the world to make a seamless transaction uninterrupted without restriction.
Yield farming on the other hand is an interesting means for users to earn extra passive income from lending their crypto holding instead of leaving their money to sit ideal in their wallet this money generates income for them by providing liquidity for smart contract pools.