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Staking, Swapping, Farming: All you need to know about DeFi concepts

A Sneak peek into the future of finance with DeFi - an exciting new concept that has swept the globe with applications like Staking, Swapping and Farming

Published: Mar 31, 2022 06:32:45 PM IST
Updated: Oct 11, 2022 01:59:18 PM IST

Staking, Swapping, Farming: All you need to know about DeFi conceptsWhat is it about a decentralized future that makes the concept so appealing? Crypto offers us a future where money and commerce can move inhibited. But how does the world really change if you remove central authorities?

To appreciate the scale of what’s in store for us, it’s best to understand how the several popular applications of Decentralized Finance (DeFi) operate and reinvent user experience.

Again - decentralized Finance (DeFi) is an emerging financial technology that promises to eliminate intermediaries in financial transactions. Having opened up multiple income streams for investors, DeFi is essentially financial services that run on public blockchains. DeFi tokens can be used to earn interest, borrow, lend, or simply trade as speculative crypto investments.

The DeFi sector has seen phenomenal growth since mid-2020. In the same way artificial intelligence and machine learning are revolutionizing the wealth management industry, DeFi is revolutionizing banking and financial services. The fact that it eliminates the need for financial bureaucracy accounts for a big part of its expansion. Because of DeFi's flexibility, it is effectively permissionless and can support third-party integrations more readily. Thanks to blockchain, everything is more transparent and traceable as well.

Another appealing feature is the concept of composability, which allows anyone to combine existing DeFi offerings to create a new one. The scalability of such a network implies that future innovations in the finance world may be readily built on top of it and connected, all under the command of smart contracts.

Although the sector is still in its nascent stages, DeFi has proved to the world that decentralizing financial services at scale is doable. With the advent of DeFi, several DeFi concepts that are transforming the financial landscape have also emerged. Some of the most prominent of these include DeFi staking, DeFi swapping, and DeFi farming. Let us look at these concepts in detail.

The future of finance reimagined with emerging DeFi concepts

•    Staking

DeFi staking involves locking one’s crypto tokens into a smart contract in an effort to earn more of those tokens in return. Consider it the decentralized equivalent of putting your money in a bank fixed deposit. With the advent of crypto and Decentralized Finance, DeFi staking has emerged as an additional way to earn profits from your crypto assets.

The DeFi staking process involves securing crypto assets into smart contracts in exchange for becoming a validator for the DeFi protocol or a Layer 1 blockchain. Typically, the staking token is the blockchain protocol's native asset.

Essentially, users become part of a network's validators when they lock or stake their crypto asset in a DeFi system. To secure the protocol's security, every proof-of-stake blockchain protocol relies on these validators. Those who have staked a portion of their token to help safeguard the network are compensated - via staking rewards.

Let’s look at an example.

Say an Ethereum token owner stakes/locks his token in the Ethereum 2.0 smart contract. He will subsequently be paid extra ETH for his contribution to the network's security. All of the processes are automated, so no manual oversight is necessary. The proof-of-stake mechanism will take care of the remainder once he has deposited or staked a token into the smart contract. After that, all he has to do is claim the staking rewards.

DeFi staking, without a doubt, provides a straightforward and simple approach to entering the world of crypto assets while also avoiding the excessive expenses associated with trading capital. To participate in DeFi Staking, you do not necessarily need to handle private keys, acquire resources, execute deals, or perform any other onerous duties, since several. As a user, staking tokens will assist you in generating passive revenue from your digital assets. If you stake DeFi tokens, the prospective interest rates will be substantially greater, and a highly secure smart contract will safeguard them.

•    Swapping

A decentralized world is a free world, one with minimal restrictions on how you manage your assets or what you transfer them into. Because it’s automated, Swapping is another method in DeFi for transferring assets. A token swap, in essence, is a mechanism in which investors exchange their existing tokens for new ones.

Token swapping is only possible with a DeFi protocol, such as a decentralized exchange, which, unlike centralized exchanges, follow the method of AMM (automated market makers) wherein the smart contract code is designed in such a way to make token swapping possible. These exchanges are non-custodial and rely on liquidity provided by users through yield farming or liquidity mining. Because of decentralization, token swapping is solely governed by smart contracts. There is no requirement for input from the exchange, and there are no elements that could lead to human error.

•    Farming

Yield farming in DeFi is the method of lending or staking your crypto coins or tokens in exchange for transaction fees or interest. This is similar to earning interest on a savings account when lending the bank money, or lending to a borrower on modern (but centralized) P2P marketplaces.

In a decentralized protocol, users move their cryptos around all the time between different lending marketplaces to maximize their returns, similar to how a bank takes a deposit from a customer and pays him a certain percentage of interest before lending the same amount to another customer for a higher interest. The difference with DeFi is the inclusion of a smart contract that replaces a central institution, lowering costs and improving efficiency.

Yield farming techniques, in essence, encourage liquidity providers (LPs) to stake or lock up their crypto assets in a smart contract-based liquidity pool. A share of transaction fees, interest from lenders, or a governance token can all be used as incentives, and these returns are typically expressed as an annual percentage yield (APY).

The majority of yield farmers initially staked well-known stablecoins such as USDT, DAI, etc. However, today, the most popular DeFi protocols run on the Ethereum network and pay out governance tokens to liquidity providers. In exchange for providing liquidity to decentralized exchanges, tokens are farmed in these liquidity pools.

Final thoughts

DeFi is rapidly evolving and expanding to replicate the traditional financial services ecosystem, and certainly, it will have a significant impact on the future of centralized finance firms. It has also provided investors with new sources of revenue, and all of this is set to change the world of finance in ways never seen before.

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