Investing in DeFi Projects – risk comes from not knowing what you are doing
You might have heard about the possibilities to make money by investing in so called DeFi projects. If you are new in the field, I would give you the advice – and this is a basic rule for all kinds of investments – to inform yourself well about what you are doing. Even the well known „father of investments“ Warren Buffet once had said: “risk comes from not knowing what you’re doing“. So, by informing yourself, your risk can always be minimized.
Unfortunately, there are also a lot of black sheeps offering DeFi Projects that literally rip off their clients and make them loose their money. Therefore, I would like to give you a tool how you can recognize frauds and thus distinguish dubious from serious defi projects.
If you plan to make an investment in DeFi projects, it is important at the beginning to fully understand what DeFi is.
So, what is DeFi?
DeFi ist he shortcut for decentralized finance. These include in general digital assets, protocols such as smart contracts and so called DApps (decentralized applications).
Decentralized finance has a main vision: Through enabling a decentralized storage of financial and transaction data, an independent financial system that is accesible for everyone should be created.
Data can then no longer be controlled by a single person or any other centralized authorities (such as banks, governments, etc.) but, instead, the participants of the network control the network decentrally. Basis for this ist he blockchain technology.
Currently, most of DeFi projects are based on the Ethereum blockchain. Developers can program applications on the blockchain that make it possibele to create, store and manage digital values, also called tokens. These applications are called Smart Contracts or decentralized applications (DApps). With these smart contracts complex irreversible agreements can be build. All oft hem run without the need of intermediares. And this ist he difference to traditional finance. To fully understand this, let’s have a look on the traditional financial markets.
Some words about history
Originally, currencies were invented to facilitate the exchange of items of different value. Money, as we know it today, was not always there. In former days, goods and services were exchanged directly between each other. As our society developed, currencies were invented to facilitate this exchange. Although this makes things easier, regarding factors like e.g. productivity, this advantage does had it‘s price.
As traditional currencies are managed by central authorities, such as goverments, banks, etc the use of governmental currencies, so-called fiat currencies, has a lot to do with (blind) trust. You have to trust that the central banks will not simply print more money overnight and thus devalue the currency.
Because the majority of people are putting the responsibility of their finances into these centralized hands, the centralized institutions have gained power and we lost our influence.
Current developments like e.g happening in Venezuela, where hyperinflation recently occurred, make some people doubt whether the current financial system should not be reconsidered.
But here is what only few people know: Alternative ways to take back the responsibility for your own finances already exist. Through inventions such as the blockchain technology, which allows us to store information in a decentralized way, there are already tools that allow us to build a financial system in which we are not dependent on centralized authorities anymore.
By introducing decentralized applications as an alternative, the dependence on this middleman can be reduced to a minimum or even completely eliminated.
What makes DeFi projects so special?
In EVERY transaction in traditional finance, there is an intermediary, usually a bank, between the two partners. This means that human monitoring bodies and institutions can not only influence the speed of a transaction, but can even control and restrict the background. In this way, a large part of your direct control over your own assets is taken away from you as a user.
So now let’s take a look at the DeFi projects: Most Smart Contracts are open source and interoperable with existing other Smart Contracts. As a user, you can check the code of the Smart Contracts and choose which services are best suited for you.
As you can see the area of decentralized finance gives us as users the possibility to create a resistant, self-determined and above all transparent financial system. AND THIS SYSTEM ALREADY EXISTS.
And it’s not only made for the techies among us: ANYONE can participate, the only requirement is an Internet connection.
The market capitalization of assets invested in Ethereum’s DeFI projects has increased explosively. Many users report that you have been able to make very high profits with it. For example by using Ethereum based lending apps, users can generate a “passive income”. They can lend their crypto currencies and earn interest.
In the next chapter I will introduce some popular use cases for DeFi projects.
What are examples of popular Applications?
Fields of application are extremely broad. Applications might remind you of financial services that you are familiar with from traditional finance. Special here is that they are decentralized versions of these services and are therefore independent versions.
The fastest growing sector within the field of decentralized finance are bond and loan platforms. Similar to traditional banking sytems, users here deposit digital assets and receive interest from other users who borrow their assets. Smart contracts bring borrowers and lenders together, enforce the terms of the loans and distribute interest. Conditions are programmed transparently in the Smart Contract on the blockchain and can be viewed by everyone. Intermediaries can thus be eliminated and higher revenues can be achieved.
If you are new within the field of decentralized finance, Liquidity Mining is easy to implement. When platforms need liquidity they often offer this possibility. You can provide the liquidity, i.e. deposit tokens and therefore you will receive a reward.
More for experienced traders is yield farming: Users can move their tokens back and forth between different lending platforms in order to generate maximum profit from different DeFi projects and tokens. With its high potential for greater profits, it is also associated with a higher risk. In addition to your own capital you can also use and lend borrowed capital in order to generate a greater profit. However, these systems are currently still very complex and often not transparent.
Stablecoins are also important for the ecosystem of decentralized. As the crypto market in general is quite volatile, stablecoins, are tied to a fixed asset, typically a fiat currency such as the US dollar, outside the crypto area.
Another use case are decentralized exchanges (DEX). DEXs use Smart Contracts to enforce trading rules and execute transactions. Advantages if you trade on a DEX with crypto currencies are, that there is no exchange operator, no registration, no identity verification and no payout fees.
Bitcoin can also be brought onto the Ethereum network in the form of “wrapped” Bitcoin (WBTC) and thus be used in Ethereum’s DeFi projects applications.
But, is it safe to invest in DeFi projects?
DeFi projects: just another bubble or technology with bright future?
One thing is clear: There is enormous potential in the field. Every day more and more DeFi projects are brought to life. But you must know: There are different degrees of decentralization when it comes to DeFi projects. Truth is, that not everything can or must be completely decentralized.
One example for this are the already mentioned stablecoins. Very many Stablecoins are not completely decentralized. Often they are backed by Fiat currencies, which are kept in a (centralized) bank.
In short, there are limitations in technology, and sometimes the lines of the DeFi projects start to blur. Over time, laws will adapt to the changing financial landscape and the place of DeFi projects in the world will become clearer. One thing you can be sure: DeFi projects will always be there.
Now tell me, how safe is it to invest in DeFi Projects
Every investment always carries a certain risk, the answere therefore is: no. The risk – and this applies to all investments, also outside the DeFi projects sector – can be minimized by knowing the products.
With bringing back finances in one’s own hands and no longer depend on middlemen, this also means that the level of personal responsibility increases.
Also, like any great opportunity, DeFi projects also carry risks. Many people believe that DeFi projects are the future of finance. Investing in new technologies can lead to large profits, but especially for newcomers it is difficult to distinguish good from bad companies, of which there are many.
There have also been many DeFi projects such as the meme Coin YAM, which have crashed and investors have lost money. Others like Hotdog or Pizza, have experienced the same fate.
Another problem that might occur ist hat smart contracts can not be changed once the rules are set in the protocol. Therefore, some DeFi projects have teething problems. Since the whole market is still very new, these are unfortunately not uncommon.
Not all that glitters is gold. To reduce your risks I want to give you some advice, that you should take seriously when investing in the field.
5 tips for investing in DeFi projects
- Inform yourself and understand the backgrounds: Especially within DeFi projects, with ist vision of independence and self-determination, you should take personal responsibility seriously. It is good to get support and advice, but the final decision should always be yours.
- clear benefit and value creation: Unfortunately there are black sheep who will try to cheat you out of your money under the guise of Smart Contracts and Blockchain technology. For example, if money is only redistributed through the Smart Contract and no clear added value is created, I would be very careful. These systems are often illegal ponzi schemes. But, you can also find many serious Products within the market of decentralized finance with added value. Products range from simple staking products to complex trading products, such as decentrally managed crypto hedge funds.
- not your key, not your money: Especially within decentralized finance, where it is no longer necessary to verify oneself and there are no central control organs, it is important to store your private keys well and securely. ALWAYS KEEP THEM FOR YOURSELF. Never share your private key with another person or even enter it on websites. So-called phishing websites pretend to be the company in order to get the private keys. Similar looking websites are set up to deceive users and get their acces data.
- Store your cryptos safe: The question may arise which crypto wallet is the right one for you. We recommend to use either an off-line hardware Wallet as for example the provider Ledger*. A free of charge possibility, are decentralized Wallets. The best known one is the application Metamask. There are also providers like PEAKDEFI. They offer an All-In-One solution. Beside the wallet, there is a DEX integrated and it is possible to buy crypto currencies directly with credit card.
- use strong passwords: It may sound banal but, unfortunately, the most common password in use still is “1234”. So when creating passwords, make sure to use individual passwords. You should also use upper and lower case letters, special characters and numbers. You can create secure passwords using password managers.
What are trustworthy DeFi projects?
I am often asked in which DeFi projects have managed to make it into my portfolio. Meanwhile there is a flood of new DeFi projects, so my portfolio adapts to the market regularly.
There are interesting Products, from simple yield farming, over lending, up to decentralized managed trading hedge funds. With one of my favorites you can currently even secure an additional 3% bonus return by using the link below.
Our portfolio includes several staking capable coins. You can generate a passive income by staking. Staking has big advantages but also some disadvantages. If you want to know what staking is, you will find my article about it here soon.
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Disclaimer: The content provided here does not represent investment advice or investment brokerage. The experience reports are no invitation to trade, but reflect only the opinion of the author. All statements on yields and price developments refer only to the past and are absolutely non-binding. In the event that users of the site make investments on the basis of experience reports, this is done entirely at their own risk.
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