What is DeFi and Why You Should Know About Yield Farming

Following the craze of initial coin offerings (ICOs) in 2017, the crypto market entered a bearish market, but various propaganda related to cryptocurrencies became an opportunity to attract a lot of attention from people at the time. The capital that survived the ICO bubble was used as a fuel for technological innovation along with the increase in VC investment, and professionals such as investors, developers, and traders entered the cryptocurrency industry.

Much of this effort and capital has emerged in DeFi, a term that encompasses a suite of protocols, applications, and financial instruments all running on layer one protocols such as Ethereum.

Today, DeFi occupies an important place in our crypto space, and it is impossible to talk about it without DeFi. So, what exactly is DeFi, and why should we care about the “yield farming” craze that started with DeFi’s rise?

Open Phemex’s Crypto Account

What is Defi?

DeFi represents an ecosystem of applications and protocols focused on improving existing financial infrastructure. The DeFi project builds its technology on top of Layer 1 protocols such as Ethereum, Cosmos and Polkadot, and most of the current DeFi development takes place on Ethereum with widespread network effects.

DeFi is the creation of an alternative financial infrastructure to existing systems (eg banks, insurance companies, exchanges, etc.). The idea is to break away from trust in traditional institutions and spread them across permissionless networks to create a more comprehensive way of currency circulation.

DeFi platforms include decentralized exchanges (e.g. DEX like Uniswap), synthetic assets (e.g. Synthetix ), liquidity pools, insurance products (e.g. Opyn), payments, loan/deposit protocols (e.g. Compound), stablecoins Everything from there is included. These platforms operate similarly to traditional financial services, but in most cases replace institutions (such as exchanges) with a set of smart contracts that operate on networks such as Ethereum.

For example, the decentralized version of Ethereum is Uniswap. The Uniswap protocol basically relies on an Automated Market Maker (AMM), a robot that makes quotes between two traded assets. It may seem complicated at first glance, but in a way it is very simple. DEXs like Uniswap (including AMM) replace an exchange’s orderbook with smart contracts in which records are shared among all participants in a liquidity pool of various assets.

Go to Phemex’s Official Website

DeFi and Centralized Cryptocurrency Exchanges

Conversely, centralized exchanges like Phemex can process trades much faster with a centralized order book than DEX counterparts. For many traders, the performance limitations of DEXs are outrageous, and they tend to prefer centralized exchanges. As Phemex CEO Jack Tao explains:

“The skills required to become a DEX are not yet fully ready, but we are exploring the possibility of transitioning to a non-custodial exchange while retaining the many benefits and security features it offers our clients. We believe that the main purpose of exchange is to effectively facilitate the exchange of value. For this purpose, centralized exchanges still have a relative advantage.”

Sustainable liquidity is a hot topic in the decentralized financial DeFi platform (eg DEX) industry. In other words, it is about continuously acquiring users in the liquidity pool. While the DeFi protocol knows that financial instruments and trading will be the first major technical incentives for the crypto market, attracting liquidity remains a challenge.

So, how do you get investors to deposit their assets into liquidity pools or DeFi platforms?

In the case of Uniswap, the fee generated from each transaction in the liquidity pool is paid to investors who deposit or “stake” their assets into the liquidity pool of the protocol. They are rewarded in a passively monetized way by providing liquidity to the protocol.

However, for more complex DeFi protocols, liquidity mining (aka “interest farming”) has been adopted as a solution to liquidity provision incentives.

Go to Phemex’s Official Website

Understanding Yield Farming

Yield Farming is a colloquial name for “liquidity mining”, a token distribution and reward incentive for users to provide liquidity to the DeFi platform. At a high level, liquidity mining can be thought of in terms of a reward-based marketing mechanism that undermines ownership to early investors to achieve widespread adoption of tokens and platforms.

Users are rewarded for initially providing liquidity to the protocol. However, liquid mining differs from Uniswap’s fee model in both the way it is performed (eg across multiple pools) and revenue (the default governance token of the DeFi platform).

DeFi protocols often define their success by deposits ( TVL ), which are USD equivalent to the protocol’s total assets. And TVL has skyrocketed in recent months with Compound Finance’s yield farming, one of the leading protocols for cryptocurrency lending and borrowing in the world of decentralized finance.

In June, Compound Finance, a major borrowing/loan pool built on top of Ethereum, announced the issuance of COMP, a basic governance token. Approximately 2,880 COMP tokens are distributed daily to Compound Finance users, including borrowers and lenders. Compound Finance is distributing governance tokens by issuing governance tokens to Compound users who provide liquidity services to the COMP token protocol.

Compound’s TVL skyrocketed following the release, and the token price exploded along with the soaring TVL. Users can use the COMP token to vote on DeFi’s decentralized consensus and community governance/participation. By encouraging liquidity, COMP lowers loan costs and increases borrower returns, which in turn attracts more users and more liquidity in a positive feedback loop.

COMP’s success spurred the DeFi protocol suite to follow a similar interest farming method with its own governance token. Other examples include Synthetix (a protocol for issuing and swapping Synths), Balancer (a DEX like Uniswap with governance tokens), and lending protocols such as Aave.

Understanding yield farming and how it works is important when entering the crypto market.

Interest farming, which is still in its infancy, has been adjusting its incentive model over the years to fairly distribute tokens, manage the protocol, and acquire users. The DeFi boom has proven that improving financial infrastructure is one of the most important early applications of permissionless networks like Ethereum. Now, attracting more liquidity, solving protocol problems, and extending functions seems to be the key.

As investors and the open source community continue to work hard to build the next generation of financial systems, DeFi is expected to see many advancements in the coming months and years.

For more information on DeFi, we recommend reading The Defiant by Camilla Ruso, Bankless, a summary of DeFi and open financial resources, and DeFi Pulse, a useful page for exploring specific DeFi platforms and their resources.

Open Phemex’s Crypto Account

What are decentralized applications (dapps)?

Decentralized applications (dapps) are software programs that are operated/maintained as a distributed network of computer nodes instead of a single server.

Comparing DApps with typical web applications is easy to understand.

DApp vs. traditional web application

Usually, any web application consists of a front-end and a back-end. The frontend, also called the client-side, refers to the screen the user touches on the website. At the same time, the backend, server-side is also running, which represents the mechanism behind the curtain to implement website functionality as the data access layer of the application.

Server-side

Metaphorically, think of a web application as a car. If the car is a web app, then the frontend includes the dashboard, steering wheel, windows, etc., essentially everything the driver sees from the interior. The back end of the car will include the engine that makes it possible to drive and so on.

Client-side

From the user’s point of view, there is no difference between a regular app and a decentralized app. Just as you can drive without understanding the structure of an internal combustion engine, there’s nothing wrong with browsing a website like Netflix or Amazon without knowing how it works.

One of the biggest differences between a decentralized application and a general web application is that a single server is responsible for hosting the front-end and back-end of a general application. Conversely, the backend of a dApp is hosted on a distributed network of synchronized servers ( computer nodes ) scattered around the world.

Decentralized apps have seen a huge resurgence in popularity after the Ethereum network went live, but it is important to understand that DApps do not necessarily have to run on a blockchain.

In fact, Napster, the first decentralized application and the pioneer of peer-to-peer online file sharing software, was founded in 1999, 10 years before blockchain was invented. Another example of a non-blockchain dApp that operates as a peer-to-peer network is BitTorrent, a popular file-sharing service, and Tor, a privacy-focused open source browser.

Go to Phemex’s Official Website

Understanding Decentralized Applications

Although the example was mentioned above, when talking about decentralized applications today, it is almost absolutely used in the context of dApps running on a blockchain.

Ethereum

The first blockchain to support decentralized applications is Ethereum. Ethereum is a next-generation smart contract and decentralized application platform designed in response to Bitcoin’s minimal program capacity.

In addition to being a cryptocurrency by nature, it is also a turning-complete protocol that runs and executes traditional computer-like scripts. However, the Ethereum Virtual Machine (EVM) is a decentralized computer that is perfectly defined by the consensus algorithm at each point in time.

It is smart contracts that enable decentralized applications designed on the Ethereum network. A smart contract is effectively a device in which code is stored on a blockchain, verified and executed autonomously. The reason it is called a smart contract is that once it is signed, it is automatically executed according to the stipulated conditions, eliminating the need for a third party to monitor or verify its completion.

In this respect, decentralized applications can be thought of as multiple interoperable smart contracts in the context of the same user interface. In terms of functionality, theoretically, dApps can provide the same service and user experience as regular apps, while fully enjoying the advantages of decentralization, such as transparency, open accessibility, continuous uptime, and censorship resistance.

Advantages and Disadvantages of Decentralized Applications

When analyzing the advantages and disadvantages of decentralized applications, we should never confuse the starting and ending points of innovation. The current technology is still very early: Ethereum was only six years old, and decentralized apps started gaining widespread adoption two years ago. Many of the disadvantages of current decentralized applications are considered to be situational rather than inherent disadvantages. In other words, there is no need to assume that the problems of the present will exist in the future.

Advantages of DApps

Zero downtime
The biggest advantage of running an application in a distributed computing network is that even if one node goes down or a component goes down, the rest of the unit still functions and can take over the work of the downed component. that there is. In this way, when the smart contract at the core of the app runs on the blockchain, the application runs without any obstacles as long as the network is alive. In addition, due to its decentralized nature, DApps are highly resistant to a wide range of security threats, including DDoS attacks, SQL injection, XML bomb, and cross-site scripting. It’s a big difference from normal apps.
Censorship – Resistant
Again, because it runs on an open and permissionless network, there is no single entity with the power or authority to prevent users from accessing or using decentralized applications.
Privacy
In general, users are free to interact with decentralized applications using only their cryptocurrency wallet, without providing or disclosing any personally identifiable information.
Transparency
Since decentralized applications run on an open and transparent blockchain, all data, including the source code of dApps and all inbound/outbound transactions, are transparently disclosed. Since all actions on the chain are completely verifiable, it adds an additional layer of security, and the dApp code can be reviewed and audited by anyone at any time.

Disadvantages of DApps

Difficult to build – Building and designing dApps is particularly difficult due to the immutability of smart contracts. Developers must plan extensively from the idea stage to build future-proof dApps. This is because once the underlying smart contract is activated, it cannot be changed. Furthermore, dApps will be built using Ethereum’s programming language, Solidity, which is not easy to learn unless you are focused solely on building dApps on the platform.

Poor user experience – In general, decentralized applications have a poorer user experience than centralized ones. First of all, since the technology is in its infancy, it is very difficult to explore, even for tech-savvy people. To make matters worse, all blockchain transactions are final and irreversible, so mistakes are unacceptable. If a user transacts wrongly on a dapp, it can be very costly, as little or no recourse is provided.

Expensive usage fees – In order to trade in decentralized applications, you have to pay network transaction fees. This transaction fee is calculated in Gas, which is Ethereum’s own price unit, and is paid in Ether (ETH), and is delivered directly to the miners who maintain the blockchain network that drives the DApp. When volume is high, a simple P2P transaction is between $2-5, but in peer-to-contract (P2C) transactions such as tokens on a decentralized exchange, you can be charged up to $20.

Slow speed – In addition to high cost, the disadvantage of dApps is that they are much slower than regular apps. This is because blockchains that use proof-of-work consensus algorithms take time to execute transactions and mine new blocks. The average block time of the Ethereum blockchain is 13.3 seconds. The throughput capacity of the network is around 15 per second, well below centralized applications. If the usage exceeds the execution capacity of the network, it means that the blockchain becomes congested and the execution transaction cost and time increase further. In this case, if the user does not pay a very high gas fee, the transaction may take several hours to be executed or may eventually be rejected by the network.

Bugs and Hacking Vulnerabilities – The risk of smart contract execution is by far the biggest drawback. While it is true that deterministic and autonomous code execution and the immutability of blockchains provide security benefits, they can be devastating when done wrong. Even the smallest coding error can cause serious errors in smart contracts, and difficult-to-check design errors can lead to loss of funds locked in the contract or unusable congestion. If a reputable audit company conducts a code audit, the average DeFi user can be relieved to some extent, but a certain degree of uncertainty still exists.

Decentralized Exchanges (DEXs) – Popular decentralized applications

Decentralized exchanges and token swap protocols are the most frequently used decentralized apps in the cryptocurrency world. Decentralized exchanges utilize smart contracts to alleviate the need to use trusted intermediaries to manage funds, lowering the risk of exchange hacking or theft of managed funds. All transactions on the decentralized exchange are conducted P2P or P2C, and funds go directly to the user’s wallet.

Decentralized exchanges are using Automated Market Makers (AMMs) rather than the usual centralized market method of setting prices and executing trades through an order book. AMM is a protocol that uses smart contracts. This creates a pool of token liquidity, pre-set algorithms, and mathematical formulas to determine the price.

Some of the most popular decentralized markets are Uniswap, Curve, Balancer, SushiSwap, DODO, Bancor, and Kyber.

In addition to simple token swap protocols, other decentralized applications within this category allow the creation and acceptance of more sophisticated financial instruments such as derivatives and synthetic assets. The most popular DApps that support synthetic assets are Synthetix, Hegic, Opyn, Erasure, and MCDEX.

DApp Loans

Decentralized Lending and Lending DApps are the second most used DeFi applications. DApps in this category allow users to borrow or borrow crypto assets against crypto collateral. There are no restrictions such as credit verification or KYC verification at this time.

The most popular dApps in this category are Compound and Aave. Compound is an AMM that automatically connects borrowers and borrowers and calculates interest rates based on the loan ratio of the applied assets. In addition, Aave also allows experimenting with Flash loans, rate conversions, and unsecured loans.

Yield-farming DApp

The Profit Farm DApp is effectively an autonomous decentralized investment fund that aggregates and allocates capital with smart contracts instead of fund managers.

The concept of the Profit Farm dApp is to automate the Profit Farm process, simply by providing rewards instead of depositing capital into various DeFi protocols. These dApps provide an automated approach to crypto investment, allowing users to socialize and benefit from gas (transaction) costs.

Users do not necessarily need to understand the operating principle of a specific profit farm dapp strategy – simply deposit cryptocurrency in the dapp and receive revenue.

Popular dApps that fall into this category include Yearn Finance, Harvest Finance, Pickle Finance, and Set Protocol.

Decentralized Autonomous Organizations (DAOs)

Decentralized autonomous organizations (DAOs) are exactly what their name implies. Instead of relying on humans and conventional hierarchical management structures to operate, DAOs utilize smart contracts to autonomously implement decisions.

DAOs have many features, but the most important one is that they allow app users to dominate in a decentralized way. The cryptocurrency space innovates and moves at a frenetic pace, helping DApps to constantly change with innovation. However, in order to innovate and evolve, dApps must make decisions that cannot be made by individuals or groups alone.

To solve this problem, among other things, dApps will form DAOs where users can vote or propose protocol changes, form non-administrative vaults to help develop money gifts, give users certain privileges or take ownership stake in dApps. distribute.

The future of decentralized applications

The most important advantage that dApps differ from regular apps is their permission-free innovation. Decentralized apps are completely open and, in most cases, have no control over them, giving developers the freedom to create and experiment, evolving the space in organic and unprecedented ways.

In addition, DApps are free from the burden of trade secrets, copyrights, trademarks or patents, so they can naturally promote cooperative innovation. This means that the entire space can benefit from personal progress built by the efforts of others.

The future of decentralized applications is undoubtedly bright – there is no bright spot in every corner.

The speed at which current dApps innovate and new dApps are built is unparalleled to anything we’ve seen before. Total value locked (TVL) on the DeFi protocol has reached $13.43 billion (USD), an increase of 2,000% to date compared to about $650 million (USD) earlier this year. Calculated by the number of unique wallet addresses interacting with the DeFi protocol, the number of new dApp users grew rapidly from 10,000 to 620,000 in 2020 alone.

If growth continues in 2021 like it did in 2020, as Bitcoin already does, decentralized applications could gain mainstream attention and attract institutional capital.

Go to Phemex’s Official Website