Decentralized Finance in 2022: What's Happening?

Decentralized finance (Defi) is one of the largest and fastest growing sectors in the crypto world. Defi enables users to engage in financial protocols that include liquidity mining, staking, and lending/borrowing. Let's have a look at some of the most popular sectors within decentralized finance.

Liquidity Mining & Decentralized Exchanges

Liquidity mining, also known as yield farming, is one sector of the Defi market that has grown considerably in the last two years. Liquidity mining is the process of providing liquidity to decentralized exchanges and decentralized applications and earning tokens in return. This is usually done with smaller crypto projects since they offer higher returns due to their increased need for liquidity. Let's go over how it works.

Let's say you're interested in using a decentralized exchange's liquidity pool to your advantage. To begin, you will need to have some digital currencies in your possession. For this example, we'll be working with Ethereum (ETH) as well as the USDC stablecoin. You won't be able to store the coins you're investing in the regular wallet provided by your cryptocurrency trading service the vast majority of the time. Instead, you must move them to a wallet that you manage directly, known as a self-custody wallet, where you control the private key and have full control over the assets.

The next step is for you to go to the DEXs website, where you will link your wallet and contribute your tokens to the liquidity pool. You may examine the potential benefits of taking a new position by going to the "pool" button, selecting it, and then clicking on the "new position" link that appears.

You have the option of selecting one of many incentive levels that are each associated with a unique interest rate that is levied on traders who actually utilize the digital funds that you are supplying. The transaction costs for mining pools are normally on the lower end for very popular cryptocurrencies and stablecoins, while they tend to be on the higher end for unusual and exotic coins.

When it comes to fees, the group of liquidity miners is allowed to split the haul obtained from the fees paid by traders on the DEX, and the size of the haul that may be split becomes bigger as the amount of trading activity rises. Because of this, a lower fee may result in a greater payment on the decentralized trading platform if the specific tier in question happens to have an exceptionally high volume of trading activity. If you have a higher share of liquidity that is locked in, you will have a larger portion of the overall pie.

Now, it is time to choose how much Ethereum you wish to freeze, and the corresponding number of USDC tokens will be allocated to you instantly. You are required to have both types of tokens in your wallet at all times, and the ratio of USDC to ETH fluctuates depending on the fee tier you choose.

After obtaining your liquidity tokens, you may settle back and relax while you await the arrival of your prizes. Pairs of risky and unusual tokens often provide larger potential payouts, but a pair of stablecoins may yield returns that are very near to zero. That's how liquidity mining works and it has proven to be popular with crypto investors.

Decentralized Lending & Borrowing

Decentralized lending and borrowing is a trend that has grown over the last two years. According to Statista, crypto borrowing and lending made up the largest portion of the Defi market in 2021. One of the reasons for its huge popularity is the lower barrier to entry for participants compared to traditional platforms that usually have a lot of red tape for users to go through.

When it comes to crypto lending and borrowing, users borrow cryptocurrency to use elsewhere in the Defi space, usually in other Dapps to stake or provide liquidity for example. This is usually done with the expectation the potential earnings can cover the interest payments and earn provide for the investor.

Compared to more conventional forms of lending, the actual lending is not being done by the exchanges themselves. The decentralized exchange acts as a medium for other cryptocurrency users who provide the exchange with the necessary tokens and liquidity to function as the lenders.

High demand for collateral is one commonality between Cefi and Defi lending. When a potential borrower applies for a loan, the exchanges will almost always demand some kind of collateral to be placed against the loan. 

In the case of crypto loans, the borrower is often required to put up collateral that is of a greater value than the amount of the loan to guarantee the return of the borrowed tokens. For example, if you wish to borrow 1 ETH, you'll be required to make a deposit using another token with an equivalent value to the 1 ETH that is being borrowed. It may be a Bitcoin or a stablecoin like USDC.

When it comes to lending terms, it differs by platform, with some offering fixed-term (i.e. 90 days) where lenders loan out their tokens for a fixed amount of time in return for a higher interest rate. Other platforms are more flexible and allow lenders to withdraw their tokens at any time, in return for a lower interest rate.

That's how crypto borrowing and lending works in a nutshell and its popularity could continue to rise as the crypto market matures.

Conclusion

Decentralized finance is one of the crypto industry's fastest-growing sectors, mainly due to the ease of access for investors and the potential for returns that may be higher than those seen in centralized finance.