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Blockchain technology has come to be an abode for financial breakthroughs for most Crypto enthusiasts, especially those who have delved into the world of Decentralized Finance (DEFI). The amazing thing about the financial opportunities within the DEFI World is the decentralized nature of the system.
The power to have full control of one's funds is not only relaxing but also gives a sense of security. We are relaxed about putting a huge amount of money into a smart contract because we know that the funds are secured to an extent and we have the power to decide when to pull out.
Nevertheless, even though the DEFI world is very rewarding, certain risks abound. It is thus important that newbies particularly, Africans are abreast of these risks before they join the ever-evolving train of DEFI.
So without further ado, here are three things one needs to know before joining the DEFI train.
1. The two-edged sword that is called Smart Contracts.
Decentralized Finance exists because of the presence of Smart Contracts, and Blockchain Tech which provides the building environment for the SmartContract. Cryptographically, and in Simpler terms, Smart contracts are self-executing contracts that automate the execution of an agreement. This way, all participants can be immediately certain of the outcome, without any intermediary’s involvement.
When we interact with Smart Contracts, we give them the right to spend our funds. This is why we are prompted to approve smart contract calls before the first transaction is executed, and in each transaction, as the case may be. Now, this permission given to Smart Contracts can be limited or unlimited as the case may be. The rule as to whether the permission is limited or not is imposed by the Smart contract creator.
So, what am I trying to say?
Before you delve into the world of DEFI, it is expected that you should be aware of the above information, especially the permission given to Smart Contract upon interaction. When you are aware that by interacting with Smart Contract you give it full access to your funds, it will prompt you to choose carefully where you connect your wallet. Again, it will also prompt you to source the tools that can be used for a successful journey in the Defi world.
2. The reward you earn is a function of your capital and the length of time you invested your capital.
In the Defi system, there is what is called APR (Annual Percentage Return) and APY (Annual Percentage Yield). The core difference between APY and APR lies in the compounding interest rate. The former (APY) takes compounding interest into account while APR does not.
This is important because it will help you formulate the right decision, on the right Defi product to join, with your available capital.
Most times, people go for products with high APR to maximize their return, however, experience has shown that products with high APR come with high risks simultaneously. Most times, the high APR drops when more people join the pool, so it is important to know this and know when to pull out.
3. There are Risks in Every DEFI Product.
DEFI products like Naked Staking, Providing Liquidity on DEX (LPing), Liquid Staking, lending and borrowing, etc. are two-edged swords. For example, LPing might come with a huge APR but there is a risk called Impermanent loss that abounds. A post will be dedicated to impermanent loss that will explain what it is, and how to tackle it.
Naked staking locks the tokens for a certain period and the tokens won't be accessible to the stakers within that period. However, there are flexible naked staking common on CEX where one can pull out at any point.
Lending and borrowing can be affected by Flash loans.
Amidst these risks, the merit therein is huge. The essence of spelling out the risks is to inform newbies of these risks to prepare their minds for them. I am a Defi enthusiast and I know how much I earn each month from all the Defi products I invested in. I also know how much I have earned from Airdrops from using some DEFI products, especially those in the Cosmos network.
In Conclusion, the DEFI world is ever-evolving with several rewarding opportunities and risks. One therefore needs to equip oneself with the right knowledge before joining this train.