How to Invest in DeFi

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Contributor, Benzinga
February 8, 2022

Want to jump straight to the answer? You can buy DeFi tokens on Gemini.

Decentralized finance (DeFi) is a relatively new phenomenon that was made possible by Ethereum’s network, or more specifically smart contracts. The main functions that DeFi serves today are in the lending and trading sectors, but the industry is quickly growing. At the start of 2021, DeFi tokens were all the rage; however, heading into 2022, many DeFi tokens have underperformed comparatively to Ethereum, Solana and other layer 1 blockchains. Given their unique use cases, buying reputable DeFi tokens now may present a good buying opportunity over the long-term.

Want to start investing in DeFi but don’t know where to start? Continue reading to learn about how DeFi works, how to invest, and ways to get started using decentralized financial applications.

DeFi Explained

To understand what makes DeFi so appealing, you must 1st have a basic understanding of Ethereum. Both Ethereum and Bitcoin run on decentralized blockchains, so no entity can control the data stored on these blockchains.

Where Ethereum differs, however, is with its smart contract capabilities. At its core, DeFi is just sets of smart contracts used to perform financial functions, such as lending and trading cryptocurrency. Whereas Bitcoin can only send and receive data about how much Bitcoin one owns, Ethereum can store code on its blockchain, known as smart contracts.

You don’t need to share your identity, make an account or be approved to use DeFi. Anyone with an Ethereum wallet can get started using DeFi applications today. 

DeFi vs. TradFi

Since these financial functions on Ethereum are run by code, much of the overhead costs associated with traditional finance (TradFi) is cut out of the equation. DeFi eliminates the need for a physical bank location, employees or long and inefficient bank transfers. Aave, one of the leading DeFi platforms, manages over $15 billion of funds with only around a dozen employees.

Since so much of the overhead costs associated with lending and trading are replaced by code, users reap much higher benefits with DeFi than TradFi. Savings account interest rates on DeFi products are over 10 times more lucrative than traditional banks, and by using stablecoins you don’t even have to be exposed to volatile crypto markets.

DeFi Investments

Thousands of cryptocurrency projects have expanded into the DeFi space, so it can be hard to distinguish between long-term DeFi platforms and cash grabs. As a general rule of thumb, if a token offers high returns for doing nothing (often referred to as frictionless yield farming) it’s likely a pyramid scheme with no long-term potential. 

It’s recommended to stick to DeFi tokens with high liquidity and large amounts of cryptocurrency staked on the platform. Generally speaking, the smaller market capitalization a token holds, the more risky the token is to invest in.

Here are some blue chip DeFi tokens with huge growth potential over the long term.

  • Aave is seen by cryptocurrency enthusiasts as the world’s bank. Of all the DeFi platforms in existence, Aave has the most cryptocurrency managed on its platform by far. Aave users can deposit their crypto to savings accounts to earn interest, and they can also take out collateralized loans to leverage their crypto positions.
  • Uniswap is the leading decentralized exchange (DEX) on Ethereum. Uniswap lets anyone trade cryptocurrency without a centralized exchange that holds their funds. Instead, the smart contract protocol interacts directly with users’ Ethereum wallets, creating a trustless, permissionless and secure way to exchange cryptocurrency.
  • DeFi Pulse Index can be bought on Uniswap, and it’s essentially a DeFi ETF. This tokenized asset represents major DeFi platforms, so you don’t need to pick and choose your DeFi investments individually. 
  • Curve is the backbone of many other DeFi platforms. It’s similar to Uniswap in that it’s an automated market maker (AMM), but it also hosts other valuable functions. The platform specializes in stablecoin assets, making tokens like DAI and USDC extremely easy to transfer with low slippage and fees. 
  • Yearn.finance has been around since the early days of DeFi. Its main product is decentralized lending, but it also offers decentralized insurance and yield farming products. Yearn.finance deploys users’ funds in other DeFi protocols, such as Aave, Compound and dydx in order to consistently offer the highest interest rates on the market. 

How to Use DeFi 

Directly interacting with DeFi programs is the best way to learn about this new and growing industry. Plus, DeFi users generate interest on their cryptocurrency. Platforms that earn interest form a great opportunity to grow your crypto portfolio without needing to continuously invest more capital into cryptocurrency.

Using DeFi applications is actually easier than you may think. There’s no need to create accounts, get approved or even verify your identity. Instead, you’ll need to send your Ethereum to an Ethereum wallet to get started. The best wallet to use with DeFi programs is MetaMask, as it has a Google Chrome extension that allows you to easily connect to DeFi platforms via your browser.

Once you’ve sent your Ether tokens to your Ethereum wallet, you can use DeFi programs in just a few clicks. After you go to a DeFi platform’s website, you’ll be prompted to connect your wallet to the website. Once your wallet is connected, you can manage your crypto directly from the program's front-end interface.

Where to Buy DeFi Tokens

Plenty of U.S. based exchanges allow you to buy and sell DeFi cryptocurrencies. Of these choices, Coinbase, Gemini, eToro and Voyager (OTCQX:VYGVF) are among the most trusted options. All these exchanges offer industry-leading security, so you can rest easy knowing your funds are in good hands. 

Coinbase is an optimal choice for new investors, as it has an extremely simple user interface that’s easy to get accustomed to. Plus, Coinbase Earn gives out free cryptocurrencies to users for simply learning more about blockchain technology.

Another great option is Gemini. If you're investing in crypto for the long-term, Gemini offers useful services to help you passively grow your portfolio. The platform has a program called Gemini Earn which allows you to earn interest on the cryptocurrency held in your Gemini account. Interest is paid in the cryptocurrency you own, so you can passively accrue more tokens with Gemini Earn.

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Cryptocurrency Price Movements

As per usual, the cryptocurrency markets have been volatile through 2021 and looks to remain this way into 2022. After reaching new all-time highs at the beginning of Q4 2021, the markets corrected Q1 2022. Cryptocurrency markets are open 24 hours a day, 7 days a week. For this reason, it's a good idea to use a portfolio tracker to stay up to date with crypto prices. For current cryptocurrency prices, check out our table below.

How Much Money Do I Need to Use DeFi?

Ethereum transaction fees, called gas, can get expensive. Gas fees are calculated based on the computational power of a transaction as well as the network congestion at any given time. To send a transaction on Ethereum, you’ll probably need to pay around $10. For trading and lending on Ethereum, you may need to pay over $100 at peak times.

Due to these high fees, it doesn’t make much sense to use DeFi unless you are managing at least a few thousand dollars. Thankfully, layer 2 solutions like Polygon, Optimism and Arbitrum greatly reduce gas fees, so you can invest a much smaller amount of money. Even a $100 investment is reasonable with layer 2 solutions, so you can start putting your money to work with almost any amount of capital.

Another option is to use alternative layer-1 smart contract blockchains, such as Avalanche or Solana. These are great options for investors who don't want to bridge funds to layer 2s, as you can simply transfer SOL or AVAX from your exchange account to the corresponding network. Fees on Solana and Avalanche are pennies, so you don't need a lot of capital to get started using DeFi.

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