Anyone with a smartphone and an internet connection can stumble their way into DeFi, it’s actually pretty easy. There are few barriers to entry — when you arrive, the options will enamor you.
Through this thing we call Web3, decentralized applications (dApps) have the ability to live on a blockchain and operate in a very secure way. Along with these new apps comes smart contracts which can process incredibly complex financial operations between users all across the world, in an instant. As a result, you are able to use this new technology to lend and borrow with just a few taps on your phone’s screen.
Upon arrival into Web3 and DeFi, you will find exchanges that will allow you to buy/sell/trade/swap/bridge crypto for other assets as well as offer tantalizing Annual Percentage Yields (APYs) for longer term investment products that greatly surpass anything seen in traditional financial markets/products. It will be common for you to see APYs that are in excess of 100% — yes, one-hundred.
When people new to DeFi see those kinds of rates of return, they get excited. This new market is extremely liquid, direct to consumer/user, and all digital which reduces the costs to transact in this financial market to pennies.
This is how someone can rake in an APY that a bank could never see, not even with their biggest clients borrowing and repaying their massive loans and accumulating huge fees along the way — they will never come close.
Primary reason for this, DeFi doesn’t require building branches, or have offices filled with professionals who service customers. Through DeFi, you get the best APYs for your money because middlemen/women are essentially eliminated from the process.
YOU become the bank — only some minor transaction fees stand between you and financial freedom.
On the flip side of this emerging market is the RISK, and a lot of it. That being said, it’s no different than traditional banks loaning money to people;
Some people have great credit and pay less in interest (which means less money/less risk for the banks) and some people have poor credit and are charged incredibly high rates of interest on the money they borrow (more money/more risk for the banks).
DeFi differentiates itself from traditional financial markets when it comes to the level of risk to investors assume upon entry in the following ways:
- DeFi is unregulated — There is no one in control of the transactions and no legal or regulatory framework to ensure transactions are secure, fair, or compliant.
- Security vulnerabilities — The technology is still relatively new, it is possible that bugs or lax security protocols could lead to financial losses.
- Lack of Liquidity — Many DeFi projects are still in the early stages and have only been tested on a small scale — there are fewer buyers and sellers and the market may be less liquid than traditional financial markets. This can make it more difficult for investors to exit positions if necessary.
- Fraud — Most DeFi projects are decentralized and often anonymous, it is possible for scammers to take advantage of unsuspecting users, either through phishing scams or other fraudulent activities. Therefore, it is important to do thorough research before investing in any DeFi project.
Risk is risk, regardless of which financial market you invest in — the difference is that traditional banks have the ability to spread this risk throughout various products and services and if borrowers default on their loans, the bank either writes the losses off to reduce their tax bill, or they sell the bad debt to another entity (and still write the loss off) to further minimize their losses.
As an individual or small project/company operating like a bank, you may not be able to absorb a great deal of risk and the result could be crippling.
In my experience, people who are on a journey to get instant wealth come from a place of desperation and are incredibly inexperienced. Risk is never really considered and as a result, they unwittingly assume too much of it (recipe for disaster).
Because of this, there are Centralized Exchanges (CEXs) and Decentralized Exchanges (DEXs) that prey (in my opinion) on these types of people and are incredibly successful at taking every penny from them. Here are just a few ways this is accomplished:
- Hidden fees and commissions — often not disclosed to the customer. New people navigate this space through trial and error, it’s incredibly common. While they work to figure it all out on their own, they rack up huge fees and pay large commissions along the way.
- Difficult to withdraw funds — in some cases, customers have been unable to access their funds at all. Ever hear the phrase “not your keys, not your crypto?” When DeFi products/services within a CEXs, you do so at their control — you don’t actually have full control of your assets with them and as a result, they can limit, block, deny access to you at any time.
- Price Manipulation — reports of exchanges manipulating the market price of certain coins in order to make more profits is not a myth. There is open source data held on blockchains which suggests this happens more often than people want to believe.
Fun fact — I love to day trade crypto — been doing it for several years. I exercise an abundance of caution when I trade in an effort to reduce as much risk as possible. Part of what I do is study how coins or tokens “act” day in, and day out. Believe it or not, they kind of assume a personality that becomes “predictable” (relatively speaking).
In the years I have been doing this, there isn’t a day that goes by where I don’t see a coin or token’s price do something uncharacteristic and it just so happens to coincide with over leveraged traders getting flushed out of their positions (shorts and longs).
I don’t believe in coincidences, not when money is to be made, or lost. Price manipulation is real.