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What is DeFi? How does Decentralized Finance work?

DeFi has undoubtedly become the next evolution of the crypto market. So what exactly DeFi means, and whether we have any investment opportunities with this market. In this article, let’s find out the answers to these questions.
Amber avatar
Viet
22 min read
Published Jul 02 2021
Updated Jun 06 2024
what is defi

What is DeFi?

DeFi (or Decentralized Finance) is a financial system in which all financial institutions and financial instruments are operated in a decentralized way. In other words, DeFi leverages the decentralization feature of Blockchain to create what is called open finance. In an open financial system, everyone has access to financial services without the need for permission of any individual or organization.

decentralized finance

DeFi is attached with the key property, non-custodial.

DeFi also has a complete structure of financial institutions and instruments like CeFi:

It also has all of the financial activities in CeFi from saving, lending, and borrowing to bills and debt payments,...

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The difference is that all of these activities are not conducted by a central organization but automatically by the smart contracts of Blockchain.

DeFi vs CeFi: What is the difference?

What is CeFi?

CeFi (or Centralized Finance) is a financial system in which all financial institutions and financial instruments are operated in a centralized way. In contrast with DeFi, custodial is the key property of CeFi. It means that all financial services will be conducted through a third party.

This is the structure of financial institutions and instruments in CeFi:

In CeFi as I mentioned above, all of the financial activities (saving, lending, borrowing, bill, and debt payment,...) will be conducted through a third party. This third party can be the Central Bank, the Government, or any financial institution.

Distinguish DeFi from CeFi

The fundamental difference between CeFi or Traditional Finance and DeFi is the custodial property.

In traditional finance, power is concentrated in certain financial intermediaries (Government, Central Bank, financial institutions). In contrast, in DeFi all of these intermediaries are removed by the power of blockchain:

Financial intermediaries are replaced by decentralized blockchains.
Traditional financial assets (fiats, stocks, bonds,...) are replaced by decentralized coins/ tokens.

The mission of DeFi is to make financial services accessible to everyone regardless of where or when, as long as they have access to the internet. This is the open characteristic of DeFi.

How does DeFi work? General characteristics of DeFi

DeFi offers a decentralized financial system, eliminating the need for intermediaries by applying blockchain technology and smart contracts. DeFi can be utilized for various purposes, such as storing and transferring assets, or taking those assets into use through dApps (decentralized applications) like Decentralized Exchanges, Decentralized Lending & Borrowing,...

DeFi is among the most practical and powerful applications of blockchain technology. It promises a future of open finance where all of the financial services are conducted in a permissionless, trustless, transparent, and non-custodial way, where people are the only owner of their assets.

Is Bitcoin DeFi?

Bitcoin is the first cryptocurrency to ever exist, and it is also the first to introduce blockchain technology. Up until this moment, Bitcoin remains the largest, most secure, and most decentralized coin in the crypto market with the highest market capitalization.

Nevertheless, as the pioneering coin in the space, it only has a few use cases compared to others. At the moment, Bitcoin is used mainly as a store-of-value asset. On the other hand, DeFi offers a variety of financial applications, like Yield Farming or Lending & Borrowing.

Not only are Bitcoin and DeFi different in their use cases, but also in their core concept.

For DeFi to operate, the application of smart contracts and blockchain is the key.
For Bitcoin, only blockchain technology is applied.

As such, it is concluded that the original Bitcoin is not and cannot be DeFi, as it runs on a blockchain where smart contracts do not exist. However, to implement the vision of Bitcoin DeFi, several blockchains have been developed, like Lightning Network or Bitcoin SV.

DeFi Applications

Decentralized Stablecoins

Stablecoin is a cryptocurrency that removes the volatility characteristic by pegging value to stable assets: gold, fiats,... Similar to fiat’s importance in traditional finance, stablecoin can act as a medium of exchange, a store of value when the market crashes, and a perfect asset for risk-averse investors when farming or borrowing in a highly volatile market like crypto.

Due to the paramount importance of stablecoin, it can be used as one indicator to forecast an ecosystem's growth.

There are 4 main types of stablecoins based on the characteristics of their collateral assets:

Full-reserve Stablecoins (Centralized Stablecoins): Stablecoins backed by fiat currency: USDT, USDC,...
Over-collateral Stablecoins (Decentralized Stablecoins): Stablecoins created when collateralizing other cryptocurrencies with a total value higher than the value of minted stablecoins: DAI, VAI,...
Non-reserve Stablecoins (Algorithmic Stablecoins): Stablecoins that are minted without any backed reserve, the price is kept stable by algorithms to constantly adjust the circulating supply: UST, BAS,...
Partial-reserve Stablecoins (Fractional-reserve Stablecoin): This is the combination of full-reserve stablecoins and non-reserve stablecoins, they have better price control than non-reserve stablecoins but are more volatile than full-backed stablecoins: FRAX.

Currently, the top 5 stablecoins by market capitalization are USDT, USDC, UST, BUSD, and DAI with the leading position belonging to centralized stablecoins (USDT, USDC). However, centralized stablecoins are showing weakness in terms of trust and legal regulations. This creates a chance for other types of currencies to gain market share.

For example, UST - an algorithmic stablecoin, recently recorded a dramatic surge in market capitalization to surpass BUSD and DAI to reach the top 3. Therefore, the landscape of stablecoins can change in the future with the leading position no longer being a centralized stablecoin but a decentralized one instead.

Decentralized Exchanges (DEX)

DEXs (Decentralized Exchanges) are exchanges of cryptocurrency running on the blockchain. DEXs remove the intermediaries in CEX (Centralized Exchange), enable peer-to-peer transactions and trading in a permissionless and non-custodial way.

As I mentioned above, DEXs exist in 2 forms: order-book and AMM (Autonomous Market Makers).

The Order-book model determines the price of an asset by matching the bid and ask price. This model is only suitable for highly liquid assets.
In contrast, the AMM model uses a mathematical formula to predetermine the price of assets. This model is more common in DeFi as it supports the trading of illiquid assets, which are the more popular type of assets in DeFi.

Currently, Curve is the protocol that captured the highest TVL in the market at ~$20B. From the picture, we can see the multi-chain trend when many native Ethereum DEXs (Curve, Uniswap, SushiSwap,…) have already been deployed on other chains.

Other than Ethereum, other chains such as BSC, Avalanche, Solana also have their native DEXs with impressive TVL, namely PancakeSwap, Trader Joe, Raydium, respectively.

Decentralized Lending and Borrowing

Lending & Borrowing is an indispensable part of any financial system as it enables people to maximize their capital efficiency. However, unlike traditional lending, all lending and borrowing activities in DeFi are facilitated automatically by smart contracts without the existence of any third party. This again creates a permissionless and transparent money market, where anyone can take part in it easily.

However, Lending & Borrowing always has default risks. These risks are even exaggerated in the crypto market due to the huge fluctuation in the price of collateral assets. That is why the most common type of borrowing in crypto is over-collateralized borrowing, which means that borrowers must deposit more than what they borrow. Some top lending platforms: AAVE, Compound,...

Cream and Mars Protocol are among a few proctors that allow under-collateralized borrowing, but this type of borrowing is only applicable to whitelisted projects, not to the community.

Liquidity Mining

Liquidity Mining can be understood as Yield Farming & Liquidity Farming.

Yield Farming activities allow users to earn extra profit from their crypto assets by providing liquidity to a protocol.
Liquidity Farming is part of yield farming, mentioning the action of users depositing assets in the liquidity pools to earn rewards: which can be the shared revenue or the governance tokens of the protocol.

The success of the Compound liquidity farming program in 2020 proves the power of liquidity and yield farming in attracting users to the platform. As a result, liquidity mining has been the most favorable strategy for any newly launched project to attract the community's attention.

Aggregator (DEX Aggregator & Yield Aggregator)

To maximize capital efficiency, a new type of protocol has been invented: Aggregator.

DEX aggregators: Provide the best trading price. Due to the slight differences in prices offered by different DEXs, users have to compare the prices manually to trade with the best price. DEX aggregators remove this time-consuming process by tapping into the liquidity pools of different protocols, automatically comparing the prices, and conducting your trade at the optimal price.

Currently, 1inch is the leading DEX Aggregator by trading volume, followed by Matcha, MetaMask, and Cowswap.

Yield aggregators: Provide the best yield. Similar to DEX aggregators, yield aggregators are able to offer the best profits by comparing yields on different platforms and suggesting the best yield strategy for users.

Margin Trading/ Derivatives

Margin trading is a way of trading that uses borrowed assets to amplify the trading results. This means that users can multiply their profits but can also lose all of their money at the same time.

Derivatives: Another tool for traders to exaggerate their profits. Traders trade against the future value of assets under a contract. In this case, people do not have to own the asset but can still benefit from its price movement.

In the crypto world, the CeFi is still outperforming DeFi in this field, with top derivatives exchanges by open interest and trade volume mostly being centralized exchanges.

Some notable projects in this field are dYdX, Perpetual, Drift Protocol, and MCDEX.

Synthetic Assets

DeFi is on the way to being able to provide any financial assets that are available in traditional finance. However, thanks to the power of blockchain, DeFi can offer even more than that, and synthetic asset is one example.

A synthetic asset is basically a tokenized derivative that mimics the behavior of another asset. Synthetic assets allow users to have exposure to any financial market by creating a synthetic version of them. For example, Synthetix - a pioneering protocol in this field, offers many types of assets from crypto, and equities to commodities.

This is one of the most convincing pieces of evidence to prove that DeFi creates a permissionless and open financial market, removing any restrictions preventing people from entering a certain market in traditional finance.

Launchpad

Launchpad is a platform that supports the initial launch of projects. With such a fast-growing space of DeFi, the launchpad has become an integral part of a whole ecosystem, offering a place for new projects to raise funds and awareness to the community as well.

This is why Launchpad is considered the driving factor of DeFi as the growth of launchpad attracts a large number of new users and bootstraps the arrival of many new projects.

NFT

NFT (or Non-Fungible Tokens) are tokens that are indivisible, unique, and ownable. Among those attributes, uniqueness is the most important one that leads to many applications of NFT.

Currently, most NFTs exist in the forms of artworks: pictures, cards, collectibles,... Unlike traditional digital artworks, which can be easily copied, thanks to the uniqueness of each NFT, artworks in the form of NFT can remain their scarcity, which captures value for them in the NFT marketplace.

The NFT marketplace recorded a hype in August 2021 with the trading volume reaching more than $1B, in which ~97% was contributed by Opensea.

However, the hype gradually faded as people saw the limited use cases of NFT. People can only use NFTs for trading and nothing else. If NFTs are not listed in the marketplace then people can only store them in their wallets.

For NFTs to revive in the future, there must be more use cases for NFTs to create motives for holding NFTs. Gaming is expected to be the leader in creating more use cases for NFT. The growth of games like Axie Infinity has made game assets (pets, lands,..) exist in the form of NFTs increase in value. What’s more, in DeFi, many projects also start to plan for more applications of NFTs: such as NFTs being used as the collateral in lending.

“Interactive NFTs” are just in the first stage but can promise to be the trigger for a more suitable growth of NFTs soon.

Decentralized Oracles

Oracle: Connect blockchain with real-world data. You can imagine the importance of oracle to a blockchain, similar to the importance of the internet to a computer.

Oracle brings the outside blockchain data to its smart contracts. Without oracles, lending protocols can not determine the price of the collateral to trigger liquidation when needed or synthetic assets can not exist due to the lack of data about the behavior of the real assets (stocks, indexes,...).

Therefore, Oracle is an indispensable part of the development of any blockchain. Some notable names in this field are ChainLink, Band Protocol, DIA,...

Decentralized Bridges

Bridge: Connect one blockchain to another. Each blockchain can be compared to a nation having its own regulation of what assets should be used in its territory. Similarly, each blockchain has its own standard of tokens (Ethereum with ERC-20, BSC with BEP-20,...) that can be used in its ecosystem.

On one hand, this ensures high security for a blockchain. Still, on the other hand, it restricts capital efficiency when one type of asset is limited to a certain chain. This is where the need for a cross-chain bridge arises, facilitating the transfer of assets among different blockchains.

Similar to a country’s development after opening trade with other countries, bridges have boosted the expansion of DeFi as a whole and of each blockchain in particular. For instance, ~25% of TVL in Ethereum is contributed from bridged assets from other blockchains (BSC, Avalanche, Fantom,..) (sources: here).

Decentralized Insurance

In DeFi, Decentralized Insurance aims to maintain users' funds while they are used for highly risky plays in DeFi.

Nevertheless, this category has not been noticed appropriately. This is clearly evident as there have been way too many hacks and exploits in DeFi with a massive amount of fund loss.

Ronin: $624M.
Poly Network: $611M.
Wormhole: $326M.
And a lot more in such a short period of time.

From my viewpoint, this category deserves better attention. In the future, Decentralized Insurance may be a promising niche to follow. Some potential projects in this field: Nexus Mutual, InsurAce, Cover Protocol,...

Others

Besides the above mentions stacks, DeFi is developing at an impressive rate to bring a wide range of financial services to users. Some other DeFi stacks:

DAO (Decentralized Autonomous Organization): A way to keep DeFi become more decentralized as it divides governance rights equally to token holders.
GameFi: GameFi combines Gaming with Finance to create a new model. GameFi develops different economic models to allow various types of earning simply by playing games.
Decentralized Prediction Market: This allows users to take part in predicting an event, facilitate the forecast of market sentiment, and hedge against risk.

To sum up this part, you can see that DeFi in 2022 is much more developed than DeFi in 2020. This is clearly indicated in the diversification of financial products offered by DeFi in 2022. This will be one of the key drivers to attracting more users to DeFi when people see that DeFi can meet all of their financial needs just like the traditional world (saving, lending, margin trading,...), even with more innovations.

DeFi Revolution

Before Ethereum, the only financial application of cryptocurrency was payment through Bitcoin. However, people wanted more than that, they desired a more comprehensive range of financial services: saving, lending, borrowing, trading,... As a result, Ethereum was introduced to trigger an era of DeFi.

The development of DeFi can be divided into 3 phases:

The early stage of DeFi (2017 - 2020).
DeFi Summer 2020.
DeFi in 2021 - 2022 (Now).

The early stage of DeFi (2017 - 2020)

The first event that started the new era of DeFi was undoubted the launch of MakerDAO in 2017. MakerDAO created the first decentralized stablecoin (DAI) that did not require trust from a centralized entity like USDT, USDC,... The value of DAI was backed by a decentralized digital asset instead of dollars reserved in banks. MarkerDAO was the first money lego that enabled the formation of many protocols afterward.

The year 2017 also recorded a new trend in fundraising - ICO (Initial Coin Offering). Protocols raised funds by exchanging their projects’ tokens for ETH. ICO created hype in the community with 800 ICOs, raising a total of ~$20B. Among them, there were still scam projects that took advantage of the overhype in the market. However, many high-quality protocols were also built at this time: AAVE, Bancor, 0x,...

The next breakthrough in DeFi is the arrival of Uniswap in 2018, which brought the new concept of an AMM DEX to the market. Other than BTC, ETH, the trading volume of many coins/ tokens was extremely small but users still had the need for exchanging these assets.

While order-book DEX failed to meet this demand, the AMM model was able to do so. Uniswap created a permissionless liquidity pool, where anyone could supply or take the assets from the protocol. This model had created liquidity for many illiquid assets to boost the trading activities in DeFi.

This phase ended with: “Black Thursday” event in March 2020: The price of ETH dropped by 30% in just 24h due to the fear of the global pandemic at that time. People rushed to pay off debt, increase collateral,.. which put pressure on the Ethereum infrastructure, resulting in a striking increase in gas fees.

The sharp fall in ETH price also led to a wave of liquidation in the borrowing market that used ETH as the collateral. MakerDAO was the most affected protocol when enduring a shortfall of ~$4M worth of ETH.

This event worked as a stress test for a nascent industry like DeFi. After this event, DeFi was even strengthened, and this brought us to the next milestones for DeFi: DeFi Summer in 2020.

DeFi Summer (March - September 2020)

DeFi Summer in 2020 was triggered by a concept called “Liquidity Mining” which was first offered successfully by Compound. To bootstrap the platform's liquidity, Compound had rewarded COMP tokens to all of its lenders and borrowers.

After the success of the Compound liquidity mining program, this method was adopted by many other protocols (Synthetix, Curve, Ren,...) to attract users to their platforms.

Yearn Finance was another notable name in this period, Yearn Finance offered a new model named yield optimizer, which even further leveraged the yield that users could earn.

Besides its success as a yield optimizer, Yearn Finance also was the project that invented the concept of a “fair launch” token. Before that, users only had access to the token sales after many seeds/ private rounds, which meant they had to buy at a higher price than a group of people. This, for many people, was an unfair way to distribute tokens.

In contrast, “fair launch” meant tokens were distributed right to the community with no pre-sales to generate a fairer game. This was precisely how Yearn Finance launched its tokens in July 2020.

After many breakthroughs in DeFi, it came to a stage when “copy-cat” projects appeared, and builders did not put effort into building new products but just copied the existing model of other protocols.

YAM protocol, which was the folk of Ampleforth and Yearn Finance, is the first project to start a series of copy-cat protocols (Pasta, Spaghetti, Kimchi, HotDog,...). Due to a lack of innovations, all of these projects failed after several days.

However, not all folks were unable to survive. SushiSwap was initially the folk of Uniswap, but up to this date, it is one of the top protocols by TVL by having a wise multi-chain expansion strategy.

To sum up, after the DeFi Summer 2020, the TVL of the DeFi market had nearly x10 from ~$1B in March to ~$10B in September 2020. More specifically, DeFi Summer 2020 had placed the foundation for the most fundamental activities in decentralized finance:

Lending and borrowing: MakerDAO, Compound, Aave,...
Trading: Uniswap, Kyber,...
Derivatives: Synthetix, UMA,...

DeFi in 2021 - 2022 (Now)

DeFi in 2021 - now can not be wrapped up in just one picture like 2020. DeFi has grown dramatically and offered nearly all desired products in traditional finance.

Some key highlights of the difference between DeFi 2021 and DeFi 2020:

DeFi does not only concentrate on Ethereum but starts moving to other chains (BNB Smart Chain, Solana, Terra, Polygon,...) with many innovations.
DeFi stacks are much more diverse with the development of many new protocols.
Many new trends have arrived: Interactive NFT, DeFi 2.0,... (mentioned above).

To better understand DeFi 2021, let’s have a closer look at each of its components in the following part.

What are DeFi Coins? How to invest in DeFi Coins?

DeFi coins are basically all cryptocurrencies that support DeFi applications.

To invest in DeFi coins, you have to pick out a few most potential ones. Here are some criteria to evaluate a good DeFi coin:

Developed under a thriving environment (blockchain in this case) with high scalability and security.
Invested by major Venture Capitals or prestigious investors.
Built by a high-quality and dedicated team with experience in the space.
Suitable with market trends or narratives.
Possessing practical and usable products for organic users.

What is DeFi Wallet?

DeFi Wallet is a type of application that acts as a wallet to store and interact with your cryptocurrencies. At the moment, there are 3 main types of DeFi Wallets:

Hot wallets or Non-custodial wallets are places to store coins/tokens online, where users have to keep the private keys to protect their own crypto assets. There are some popular wallets for storing crypto assets, namely: Coin98 Wallet, Trust Wallet, Metamask, etc.

Cold wallets exist in the physical shape (usually as a USB) that require multiple security steps. Investors often use cold wallets for long-term coins/tokens storage. This complexity enhances the security of the wallet in return. Some popular cold wallets are Ledger, Trezos, etc.

Wallets on exchanges or Custodial wallets, basically, users don’t own any private key, they access their funds by password kept by the exchange. Since investors store their crypto assets on exchanges, there are potential risks of scams and shutdowns. Binance, Okex, and Coinbase are the most popular centralized exchanges.

What is DeFi Ecosystem? Some DeFi Ecosystems you should pay attention

As mentioned above, DeFi has various decentralized applications forming a financial system. When they are built on the same blockchain platform, they will create what is called a "DeFi Ecosystem". Ethereum has been the most developed DeFi Ecosystem as it has the highest number of projects as well as dApp categories.

Besides the diversification in the financial services, the development of DeFi is also represented by the rise of many blockchains other than Ethereum. At the end of 2020, the TVL of Ethereum still accounted for 97% of the total TVL of DeFi. However, at the end of 2021this number has reduced to 66% with the expansion of other chains: Binance Smart Chain, Solana, Avalanche, Terra,...

BNB Smart Chain (BSC)

BSC is currently the 2nd biggest blockchain by Market Cap in the whole DeFi Market. It is the first blockchain to capture the TVL outflow from Ethereum.

The skyrocketing growth of Ethereum resulted in recurring congestion and an extremely high transaction fee on this network. The average transaction fee had reached ATH at ~$70 in May 2021, posing a huge scalability problem for Ethereum. While at that time, the DeFi ecosystem of BSC had offered the most fundamental DeFi stacks so users started to move their assets to this network to find new investment opportunities.

May 2021 was also the period that the TVL in BSC reached ATH at $32B. BSC led by CZ, one of the most influential figures in crypto, was the creator of many trends in the market: from “NFT” in June to “GameFi” in July and “Metaverse” in August.

After the period of “overheating”, the BSC ecosystem has come to the “cooling” period. However, with the support from a giant like CZ, BSC is still expected to be a key player in this fast-growing market.

Terra

Terra is the second biggest DeFi Ecosystem in terms of TVL. Terra builds an algorithmic stablecoin, UST, as the core product of the ecosystem. By expanding the use case of UST across numerous different platforms, Terra has been able to scale its ecosystem to the next level of mass.

Even though DeFi exists on Terra, its main focus is actually not DeFi. Instead, they focus primarily on developing UST. This is done by getting UST to be used by more products and more users through applications like Lending & Borrowing, Payments, Synthetics,... At the moment, Anchor is the biggest project on Terra by allowing UST farming with high yields.

Solana

Solana is one of the most notable names in 2021 when recording tremendous growth in the past year. Similar to BSC, Solana is led by one of the most influential players in crypto - Sam, founder of FTX exchange.

However, unlike BSC - built as an EVM-compatible chain, which means that projects on Ethereum can be easily deployed on BSC, Solana is a non-EVM-compatible chain. Therefore, Solana is said to be a blockchain with many innovations.

Up to this date, Solana has had projects in different DeFi stacks: from DEXs, yield farming to derivatives, prediction,... However, the TVL is not distributed evenly among DeFi stacks on Solana, with the vast majority of TVL still concentrated on DEXs and Assets (yield protocol). Therefore, Solana remains a hugely promising blockchain with the explosion of other DeFi stacks soon.

Other blockchains

Besides Binance Smart Chain and Solana, DeFi 2021 saw the rise of many other blockchains: Avalanche, Terra, Fantom, Near,... Each chain is building its own DeFi ecosystem to attract users.

The money in DeFi is constantly seeking for the chain with the highest earning potential, so you should follow the change in TVL constantly together with the market sentiment to spot your own investment opportunities in this market.

The Future of DeFi

DeFi is constantly developing to offer better experiences for users. Recently, we saw the rise of the new term “DeFi 2.0” as a new phase of development for DeFi. So what problems DeFi is facing right now and how DeFi 2.0 can be a solution for those issues:

Liquidity

Liquidity is a key requirement for the development of any financial market. Most protocols are bootstrapping liquidity by liquidity mining programs with high APY. However, this technique generates unsustainable liquidity for the protocols as users leave the protocol as soon as the APY decreases and the price of the protocol tokens will dump aggressively.

A solution for this is to lock the yield to ensure sustainable capital in the protocol. One protocol that applies this technique is Olympus DAO. It uses the bond model in traditional finance to payout yield for users, which means that instead of paying all yields in one day, the yields will be divided to be paid evenly for 5 days. This prevents the dump in the price of farming tokens when peoples sell yield tokens immediately after earning enough.

Decentralization

Decentralization is among the key properties that define DeFi. However, the DeFi market is actually not as fully decentralized as people expect. One example is the case of Uniswap when the community was unaware of the proposal to sell a $20M UNI token for the “DeFi Education Fund”. Even after acknowledging this plan, the vote of each individual in the community was powerless as the number of “yes” votes had already been dominant by a group of powerful people.

DeFi 2.0 solves these issues by what is called DAO (Decentralized Autonomous Organization). Instead of running by the control of humans, DAO uses the power of blockchain to run automatically by a series of coded rules. The key highlight of DAO is that DAO ensures every member can easily access and vote for any raised proposals in the most decentralized way.

Capital Efficiency

TVL in DeFi is increasing at an impressive rate, but a large proportion of that has not been utilized efficiently.

AMM: due to the fragmented liquidity design of most AMM protocols, the capital efficiency in AMM is quite limited
Lending: the utilization rate is still low (lenders > borrowers)
Farming: the interest-bearing tokens (tokens received when staking in farming vaults) have no use cases

Some of DeFi 2.0 protocols have offered solutions for those issues. For example, Uniswap V3, with the design of centralized liquidity, has maximized the capital efficiency insides its liquidity pool, while Abracadabra offers a use case for interest-bearing tokens when they can be used as collateral to mint stablecoins. All of the innovations in the design of DeFi 2.0 protocols have boosted the capital efficiency in DeFi.

In case you want to learn more about DeFi 2.0 and its Future, this article will be useful for you: What is DeFi 2.0?

Investment Opportunities with DeFi

DeFi is a young market compared to other financial markets like stock, gold,... Therefore it offers high returns but also has extremely high risks, so you should do your own research before making any investment decisions. The following part will be some suggestions of how to earn from this market that you can read as a reference.

Invest in DeFi coins/ tokens

It may be the most common and easy way to start investing in DeFi. Each project tends to have its own native token that offers its own upside opportunities. Due to high risk, the extent of an upside in crypto is also much more significant than any other traditional market.

IDO, IEO, IGO, IFO

Despite different names, they are basically a method that you can buy a coin/ token/ NFT at its first initial public offering price. The potential returns from this method are also impressive. You can take the ATH ROI of projects launched IFO on Pancakeswap as a reference.

Airdrops, retroactive

This is a way a project reward tokens for its early supporters. Therefore, by experiencing a protocol at an early stage, you own a chance to receive a huge amount of rewards from the protocols.

Skin in the game

This is when you become a real user of DeFi, as a participant in this financial market. As I mentioned above, DeFi has offered nearly complete financial services like traditional finance: saving, lending, margin trading,... so you can leverage your capital by utilizing all of DeFi services.

Farming” is one of the most favorite “skin in the game” activities when users can earn from their initial capital with a much higher interest rate compared to traditional finance.