What is DeFi?
Before we can talk about DeFi staking, we need to ensure that you all know the basics. Decentralized finance, or DeFi, is a relatively new term that came to life back in August 2018. However, while the term was born during a Telegram chat between Ethereum developers and entrepreneurs, the concept of DeFi dates back to 2009. This was Bitcoin’s inception, and Bitcoin was the first public distributed ledger (blockchain). Furthermore, Bitcoin (the chain) also came with its native cryptocurrency, BTC (Bitcoin). Nonetheless, Bitcoin was created to support peer-to-peer (P2P) transactions. Moreover, since transactions are a pretty important part of the financial ecosystem, we can consider this as the beginning of DeFi.
However, it wasn’t until the first programmable blockchain, Ethereum, that DeFi in its full glory became possible. As you may know, the pieces of software that make interaction with programmable blockchains possible are smart contracts and dapps. Smart contracts exist to ensure that on-chain transactions run according to standards and protocols. As such, predefined actions execute when predefined conditions are met. Moreover, dapps ensure that users get to interact with chains.
With that in mind, the main idea of DeFi is to offer all the useful concepts of traditional finance (TradFi) and make them decentralized. That is, to make them propelled by distributed pieces of hardware and eliminate countless middlemen attached to the traditional financial system. Of course, not all DeFi applications are equally decentralized; thus, centralized finance (CeFi) is also a thing. There’s also the question of proof-of-work (PoW) vs proof-of-stake (PoS) blockchain mechanisms. However, let’s leave these details for a later discussion. So, since DeFi uses existing financial concepts, it seems fair to do a quick overview of traditional finance.
What is DeFi Staking?
Now that we all have a solid understanding of what DeFi is, it’s time to zoom in on DeFi staking. So, what is DeFi staking? This concept evidently has something to do with decentralized finance and staking. Further, there are two different interpretations of DeFi staking. If we consider the concept in its most “to-the-point” definition, it focuses on staking crypto assets in order to become a validator in a layer-1 blockchain or a DeFi protocol. By “staking crypto assets”, we refer to locking fungible or non-fungible tokens (NFTs) into smart contracts. Moreover, in exchange for staking crypto assets, users earn rewards for the duties their staking performs. On the other hand, if we look at DeFi staking from a broader perspective, it refers to all sorts of DeFi activities that involve a temporary commitment of crypto assets.
The future of finance reimagined with emerging DeFi concepts
DeFi staking involves locking one’s crypto tokens into a smart contract in an effort to earn more of those tokens in return. Consider it the decentralized equivalent of putting your money in a bank fixed deposit. With the advent of crypto and Decentralized Finance, DeFi staking has emerged as an additional way to earn profits from your crypto assets.
The DeFi staking process involves securing crypto assets into smart contracts in exchange for becoming a validator for the DeFi protocol or a Layer 1 blockchain. Typically, the staking token is the blockchain protocol’s native asset.
Essentially, users become part of a network’s validators when they lock or stake their crypto asset in a DeFi system. To secure the protocol’s security, every proof-of-stake blockchain protocol relies on these validators. Those who have staked a portion of their token to help safeguard the network are compensated – via staking rewards.
Let’s look at an example.
Say an Ethereum token owner stakes/locks his token in the Ethereum 2.0 smart contract. He will subsequently be paid extra ETH for his contribution to the network’s security. All of the processes are automated, so no manual oversight is necessary. The proof-of-stake mechanism will take care of the remainder once he has deposited or staked a token into the smart contract. After that, all he has to do is claim the staking rewards.
DeFi staking, without a doubt, provides a straightforward and simple approach to entering the world of crypto assets while also avoiding the excessive expenses associated with trading capital. To participate in DeFi Staking, you do not necessarily need to handle private keys, acquire resources, execute deals, or perform any other onerous duties, since several. As a user, staking tokens will assist you in generating passive revenue from your digital assets. If you stake DeFi tokens, the prospective interest rates will be substantially greater, and a highly secure smart contract will safeguard them.
A decentralized world is a free world, one with minimal restrictions on how you manage your assets or what you transfer them into. Because it’s automated, Swapping is another method in DeFi for transferring assets. A token swap, in essence, is a mechanism in which investors exchange their existing tokens for new ones.
Token swapping is only possible with a DeFi protocol, such as a decentralized exchange, which, unlike centralized exchanges, follow the method of AMM (automated market makers) wherein the smart contract code is designed in such a way to make token swapping possible. These exchanges are non-custodial and rely on liquidity provided by users through yield farming or liquidity mining. Because of decentralization, token swapping is solely governed by smart contracts. There is no requirement for input from the exchange, and there are no elements that could lead to human error.
Yield farming in DeFi is the method of lending or staking your crypto coins or tokens in exchange for transaction fees or interest. This is similar to earning interest on a savings account when lending the bank money, or lending to a borrower on modern (but centralized) P2P marketplaces.
In a decentralized protocol, users move their cryptos around all the time between different lending marketplaces to maximize their returns, similar to how a bank takes a deposit from a customer and pays him a certain percentage of interest before lending the same amount to another customer for a higher interest. The difference with DeFi is the inclusion of a smart contract that replaces a central institution, lowering costs and improving efficiency.
Yield farming techniques, in essence, encourage liquidity providers (LPs) to stake or lock up their crypto assets in a smart contract-based liquidity pool. A share of transaction fees, interest from lenders, or a governance token can all be used as incentives, and these returns are typically expressed as an annual percentage yield (APY).
The majority of yield farmers initially staked well-known stablecoins such as USDT, DAI, etc. However, today, the most popular DeFi protocols run on the Ethereum network and pay out governance tokens to liquidity providers. In exchange for providing liquidity to decentralized exchanges, tokens are farmed in these liquidity pools.
DeFi is rapidly evolving and expanding to replicate the traditional financial services ecosystem, and certainly, it will have a significant impact on the future of centralized finance firms. It has also provided investors with new sources of revenue, and all of this is set to change the world of finance in ways never seen before.
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