To position Islander as a learn-to-earn & affiliate marketing platform promoting crypto adoption, Islander is not only a place where retail investors can find and learn from potential projects but also provides informative news. Currently, our primary goal is to serve as a springboard for the top initiatives in the Avalanche ecosystem. So, with this “Avalanche How-to” series, we will provide you with the fundamentals of this potential ecosystem.
I. What Is Decentralized Finance (DeFi)?
Decentralized Finance (DeFi) is an emerging financial technology based on secure distributed ledgers similar to those used by cryptocurrencies. The system removes banks and institutions’ control over money, financial products, and financial services.
Some of the key attractions of DeFi for many consumers are:
- It eliminates banks and other financial companies’ fees for using their services.
- Instead of keeping your money in a bank, you hold it in a secure digital wallet.
- Anyone with an internet connection can use it without needing approval.
- You can transfer funds in seconds and minutes.
How it’s different from centralized finance
In order to understand decentralized finance, we must first take a better look into the existing centralized traditional finance system.
For centralized finance, your money will be kept by banks or other financial institutions, which are essentially the institutions that buy and sell cash flows. The system consists of various third parties who perform multiple roles to ensure that the money sent from one person would reach another person’s place via a system of interconnected host computers worldwide.
For example, when you purchase something at the mall with a credit card, the acquiring bank would request the payment amount, and the acquiring bank would forward the request to the credit system. After having authenticated and approved your valid payment request, the credit system will forward this request to your issuing bank. Your issuing bank would then approve the request and send the said amount of money from your credit account to the receiver’s bank account through the acquiring bank.
Each of these steps does cost money. All of the third parties participating in this process (namely, the acquiring bank, the credit system, and the buyer’s issuing bank) would take small commissions away from the buyer’s payment to fund their own operation. Most of the time, these service fees are paid by the seller; for that reason, most of the time, they would be added to the price of the product you’ve bought.
Keep in mind that, besides the small cost, each of these steps also requires approval and authentication. Thus, the more complex procedures and tasks (such as loaning or paying off a loan) could take days or even be denied. When you go on a vacation somewhere, there is an entirely legitimate chance that your credit card may not work because the 3-party system of the acquiring bank, the credit system, and the issuing bank might somehow not be connected on a communicable system.
Money is such a sensitive issue, and incredibly more so now because most of the world’s money exists in the form of credit, not cash, the transactions need to be treated with utmost caution to strictly avoid any serious error, such as the money had been debited from the sender’s account but not credited to the beneficiary account; a lot of money being credited in the system without any money being debited or vice versa; etc. As a result, the institutions need to base their operation on a stringent protocol to ensure monetary security. This causes the system to become much more cumbersome because many procedures would be required, and a lot of resources would be required to perform those procedures. Throughout history, humankind has come up with some of the best finance systems they have ever had. However, those are not necessarily the best that we could have.
With the emergence of blockchain technology, humankind’s financial activities have been supported at a whole new level, where it is guaranteed that serious errors like we mentioned will never happen, while the cash flow could still be mobilized quickly and efficiently. The development of security protocols, connections, the effectiveness of the software, and the hardware breakthroughs that came along with blockchain technology helped create a peer-to-peer financial network that could perform almost every function of the traditional finance system.
Whenever the users have an internet connection, they can perform transactions for loaning, depositing, etc. any of these tasks would be secured and verified by the peer-to-peer finance system. This decentralized database operates by collecting and consolidating data of all users from all over the world and authenticating each specific translation by the consensus mechanism. Whenever a transaction emerges, the entire system (consists of all the hosts in the system) would record and verify it, and as such, it would be impossible to replace, edit, interfere with, or duplicate that transaction for fraudulent purposes. To put it simply, blockchain solved the problem of mobilizing money much more efficiently because, due to its particularities, the mechanism of blockchain technology matches the traditional system: It allows the tasks traditionally done by banks and financial institutions, such as recording data, authenticating transactions, communicating, etc., to be performed entirely by unmanned algorithms.
The decentralized finance system built on blockchain eliminates the involvement of traditional financial institutions and thus eliminates related costs and processing delays globally while still ensuring safety and security.
And with that, everything the users need would be just a device that can access the internet and an internet connection. With that, they would be able to access their crypto wallets and use the dApps readily integrated into the wallet to access the DeFi service provider platforms.
For the time being, the DeFi services that have become profitable include peer-to-peer swapping (swapping your tokens for other tokens or goods), token lending and borrowing, staking for interest, fundraising and funding.
We will provide down below more detailed instructions on how to participate in DeFi on Avalanche. But why Avalanche?
II. What is Avalanche
Any DeFi system has to be built on an existing smart contract platform, such as Ethereum, Binance Smart Chain, Solana, Avalanche, etc. These smart contract platforms are currently competing directly with each other; they are in an arms race to enhance security, improve scalability and customizability, increase transaction processing speed, or be more energy-saving and environmentally-friendly. So basically, as blockchain technology is more or less still in its infancy, there is still plenty of room for more customization of smart contract platforms to help them become even more efficient.
Avalanche is a new-generation smart contract system that has only been recently developed; and it is competing directly with Ethereum with perceivable advancements, such as infinite transaction per second (compared to Ethereum’s 14 tps), transaction processing duration of fewer than 2 seconds, high level of security, all based on Proof of Stake mechanism.
Thanks to the technological advancement in smart contracting, the DeFi systems built on Avalanche are also more competitive than those built on other blockchains. For example, transactions on Avalanche-based DEXs cost way less than on the Ethereum-based DEXs.
So, how can you start to use DeFi on Avalanche?
III. How to DeFi, on Avalanche
First, you will need to own a crypto wallet (SafePal, Trust Wallet, Metamask, Coin98 Wallet…) in order to create your Avalanche wallet address and to use the DeFi dApps that will be mentioned below.
Below are some of the platforms which provide the service for you to raise funds for your own project or to fund other projects.
Avalaunch is a platform that helps new projects to conduct their IDOs, and users can participate in funding these projects to own their tokens from an early stage.
In order to participate in the funding, you will need to own a certain amount of XAVAs (the tokens of Avalaunch), and you will need to stake those XAVAs for a certain amount of time. This staking must meet specific requirements of Avalaunch on the number of tokens being staked and the staking period. The users will receive interest for their staking, as well as the right to purchase tokens of the project being IDO-ed.
As a note, you won’t be able to unstake the XAVAs before the end of the staking period and will be fully impacted by any price fluctuation during the staking period.
2. Borrowing and lending
When you own some tokens, instead of selling them for stable coins or swapping them for other tokens, you can also collateralize them to borrow stable coins or tokens of certain types without having to sell the tokens that you own.
This is the most anticipated borrowing and lending system on Avalaunch at present, a non-custodial decentralized borrowing and lending protocol. Benqi provides the core functions of traditional banks, such as collateral loaning, depositing, and loaning for interest.
Benqi also acts as a bridge over to the Ethereum network, which allows Ethereum to enjoy the benefits of a DeFi system on Avalanche, and thus bypasses the limitations of Ethereum (namely, the high transaction fee, the long processing time).
As a note, it is necessary for you to pay close attention to the interest as a lender or a borrower to make sure that the return of your investments outweighs the potential damage from price fluctuations. As a borrower, you need to repay while also ensuring that your collateral doesn’t devalue so much that your account gets liquidated (and your collateral is lost).
3. Decentralized exchanges (DEX)
It’s a place where users can conduct peer-to-peer swap transactions.
Pangolin (PNG) and Trader Joe (JOE)
On both platforms, users could perform the core functions of any DEX, such as peer-to-peer swap of tokens and liquidity provision (making others’ transactions easier to perform) for commission. The tokens of all Avalanche-based projects could be purchased here. In addition, the users can also stake singular tokens or tokens in a trading pair for a return of tens or even hundreds of percent per year paid in either PNG on Pangolin or JOE on Trader Joe.
And on top of that, there are more to come: Trader Joe is also has a plan to provide borrowing and lending services, to become a more user-friendly end-to-end DeFi platform; or, in the case of Pangolin, the users will be able to use Apple Pay or Credit Card to purchase tokens.
As a note, liquidity provision also runs many risks related to price fluctuations, so the investors must calculate with utmost caution to ensure that the potential return outweighs the potential asset damage from tokens’ price fluctuations.
Some other notable DEXs: Lydia Finance, Canary Exchange, Elk Finance, and Olive Cash. Out of which, Elk Finance and Olive Cash are multi-chain networks.
4. Investment tools
Penguin Finance (PEFI)
Penguin Finance offers a handful of financialized games, gamifying regular investment activities to make them more exciting while still generating returns. What’s more, the users may also do betting, farming, participating in charity events, owning NFTs, etc.
Yield Yak (YAK)
Yield Yak is an automatic farming platform, which provides a place where the users could deposit their LP (liquidity pool); it would automatically reinvest your rewards, show compound interests, and divide up the investment cost to maximize the farming efficiency.
However, Yield Yak has yet to be rated highly in terms of security, despite how it is still currently functioning without any problem.
Both of these tools are made for long-term investment purposes but have not yet achieved the level of popularity or public confidence sufficient for such purposes.
IV. How it really works
It should be noted that DeFi is currently still in its infancy, and, as a result, there have been quite a few incidents related to hacking, flash loans, fraudulent projects, or similar problems, costing the investors their investments. The tokens with interest receivable could suddenly plunge in price, causing the genuine interest to be not as high as initially promised.
However, these technical and operational issues do not necessarily have much to do with the viability or future potential of DeFi, nor do they make up any ground for any conclusion that this model would not work.
For example, when you want to borrow, you would have to collateralize an amount of asset bigger by a certain percentage than the amount you borrow, and the algorithm will calculate that percentage; so while there is the risk of the borrower not paying the debt, that risk would not be borne entirely by the lender alone, On top of that, the borrower would also have to pay a certain percentage of interest, and that interest would become the lender’s return. The platform will trickle a proportion of the interest or the transaction fee (or both) to fund its own operation. It would thus be a win-win model for all participants.
Another example is when you do some staking or farming: the tokens you receive are initially provided and distributed by the projects’ owners. For example, if you stake JOEs to receive more JOEs as rewards, the amount of JOE you receive will originate from a separate fund that Trader Joe created to serve staking operations. This is also true for many other projects. This method for distributing tokens is chosen by many projects, in order to attract more investors and to convince the investors to hold their tokens for an extended period of time.
Or when you provide liquidity by matching tokens into trading pairs, you are helping other peer-to-peer users’ transactions become easier and more efficient. The liquidity pools will help the AMM (Automatic Market Maker) arrange suitable bidding pairs to evaluate tokens, helping the buyers and sellers. Thus, each time a transaction appears, the buyer and the seller will pay a small fee to the DEXs, and the DEXs will use a proportion of that fee to pay commissions to liquidity providers. The return you receive originates precisely from the fee paid by the users who are looking to trade their tokens. The larger the trade volume, the bigger return you receive.
As such, the return earned from DeFi is perfectly legitimate and explainable.
Keep following us and stay tuned, we will have many other articles to break down the terms and mechanisms that we mentioned earlier in more detail.
Note: This article should not be construed as investment advice of any form. The cryptocurrency market contains various kinds of risks, and the viewer should be entirely responsible for any of their investment decisions.