DeFi Investment Guide 101
DeFi or decentralized finance is a broad term that is used to refer to the blockchain-based ecosystem. It includes everything from cryptocurrency, NFTS, and digital securities. It also includes various financial services that permit trading, loans, and interest accounts on the blockchain. DeFi is reliant on cryptocurrencies for transactions. There is a wide range of DeFi investment opportunities in the crypto ecosystem. It allows for innovative and novel ways to generate an income passively.
There are over 100 DeFi projects that are currently active in the crypto ecosystem. And while even a beginner can easily get into it the sheer numbers can be overwhelming. Before you start your DeFi investment, you need to learn how to invest in DeFi. For that, you need to understand the various factors that affect it and then choose the appropriate option.
How do you evaluate a DeFi project?
Below are the factors to consider before investing in DeFi.
The crypto ecosystem is largely unregulated. Moreover, frauds, exploits, and rug pulls are common. As such, it is important for investors to thoroughly research the background of the platform before investing. Understand how they provide security for their assets and their company policy in case of a breach. Reach security audits that are regularly done by independent cybersecurity firms. Takes these assessments into consideration and only then invest in DeFi.
Total Value Locked
TVL is used to refer to the sum of the value of all the assets in a DeFi project. In many ways, it is similar to a company’s market cap. A high TVL means investor confidence is high and the project is likely to be secure and legitimate. Such DeFi projects are also perceived to have more upside potential compared to those with low TVL. The general rule of thumb is to invest in DeFi with high TVL unless you are very confident in yourself.
Stability of Token
Look for DeFi projects whose token shows a consistent long-term uptrend. Many tokens swing wildly. And while the prospect of high short-term returns is enticing, it is better to stay away from such tokens. These tokens are often a part of the pump and dump scheme to create price hikes.
Unfortunately, such plots are quite common in crypto scape and it’s the low cap token where such occurrences happen. Thus, investors should stay away from short-term prospects in absence of proper indicators. Invest in DeFi tokens based on its fundamentals and prospects of long-term growth.
Fully Diluted Valuation
FDV is the market cap of the DeFi token relative to the market price and the number of coins in circulation. Any investor needs to consider the FDV of a DeFi token before investing. If the FDV is low, then it means that the production of new tokens will outpace the demand for new tokens. Over time, this will lead to consistent price drops in the value of the token. Always invest in DeFi tokens with high FDV.
DeFi Investment Options
Below listed are the some of the top defi investment options:
It is one of the simplest ways to invest in DeFi. All it entails is the locking of your idle assets through a contract for a stipulated period of time. And the investor will continue to earn a percentage return based on the assets locked. They are similar to fixed deposits in banking. Staking turns an investor into a validator in a proof of stake network, which is different from proof of work networks.
However, proof of stake networks gives rewards to validators just like proof of work networks do. In DeFi, the reward for staking usually consists of governance tokens. This increases the voting power of the investor in the DeFi project and can also be traded for other cryptocurrencies.
This DeFi investment strategy allows investors to lend their crypto assets to someone else and charge interest on it. It benefits both the lender and the borrower. It allows long-term investors the option to lend and earn more while short-term traders can use this to increase their margin. This also allows users to borrow at a lower rate than DEX through fiat currency exchanges. They can then use it to exchange fiat for a cryptocurrency and lend it to a DEX.
Yield farming combines three things- staking, borrowing, and lending to optimize earnings. They have high returns and high risks much like cryptocurrencies. In yield farming, investors use their staked assets as collateral and take out loans. These loans are then used to buy tokens with a high potential upside.
This allows you to maximize the reward of staking. On one hand, the investor earns guaranteed returns from staking, on the other they earn from crypto trading. However, the risk is also high as it can lead to the loss of your staked asset should you turn a loss. Yield farming is popular because unlike banks, there are not a lot of requirements. All the investor needs are staked assets. No checks are performed and so the process is quick and easy.
Other than this, some DeFi investment pools also support token pairs to generate returns. By investing money in this, the user can earn a percentage-based fee each time the token gets used in a transaction. Greater demand for some token pairs converts to a higher volume of trade and thus better returns for the investors.
These are much like index mutual funds, that track a whole index and provide aligned returns. DeFi indexes work on the same principle but instead track crypto tokens. DeFi indexes also provide their investors with a mix of diverse crypto assets in their portfolios. In many ways, their structure is quite similar to ETFs.
DeFi indexes are usually safe when considered with other investment strategies and are based on long-term growth. Their volatility is also low and for this, they’re considered one of the best DeFi investing strategies.
The relatively safe and diverse investment opportunities in DeFi coupled with long-term growth prospects make DeFi investing very lucrative. The DeFi ecosystem and the technology that drives it will inevitably improve over time. Vulnerabilities and risk will decrease and its attractiveness as an investment and finance tool will increase. Be among the smart ones, learn all about DeFi investment and never miss good opportunities to generate returns in DeFi.