Here we look at five important aspects of DeFi that every investor and staker should know:
1. Impermanent Loss
Impermanent Loss refers to the loss incurred when an asset’s price in a liquidity pool diverges from the price of the same asset in the open market.
In an Automated Market Maker (AMM) like Uniswap (UNI), crypto-asset prices in liquidity pools (LPs) aren’t connected to their respective prices on centralized exchanges (CEXs).
When a liquidity provider stakes a crypto-asset in one of these pools, they do so at a given ratio between two crypto-assets and get a claim of the pool dependent on their investment size.
If the dollar value of one of these assets changes, the LP relies on arbitrage to change that ratio such that it matches the crypto-assets respective dollar prices.
Unless this ratio returns to the state at the time of investment, the staker loses out permanently. However, since this is always a possibility, the loss is described as impermanent.
2. Transactions Can Fail in DeFi
Yes, and you will lose any fees paid. In a decentralized exchange (DEX), all transactions occur on the chain level via smart contracts. Users pay fees to execute each transaction.
DEX users have the ability to set their own fee (although they can use default options). If the amount is too small and an operation involves multiple transactions, if the amount runs out, transactions are returned to their “original state”.
There are many more reasons why this can occur too! See here for more information.
3. Uniswap Is Not The Only DEX
SushiSwap has many forks itself from SakeSwap to Kimchi Finance. And then there are other entirely different DEX platforms. Take the Solana (SOL) ecosystem, for example. It hosts Project Serum (SRM), a DEX built on SOL’s protocol.
4. IFOs Are The New IDOs
Every DeFi user has heard the term “Initial DEX Offering” by now. An IDO is a project’s native token launching on a DEX like SushiSwap.
Users can then usually exchange other cryptocurrencies for this new token. However, there is a newly popular type of launch, “Initial Farm Offering” or IFO.
An IFO launches a new token to a liquidity pool (LP) in which liquidity providers can stake cryptocurrencies and earn the new token as part of the LP’s interest reward.
Several new tokens, including Reef Finance, launched on Binance Launchpool using this method.
5. Code Is Never Complete in DeFi
Finally, the prevailing philosophy in the DeFi space is “testing in prod.” Simply put, most DeFi projects are entirely experimental whilst being open for public use.
As a DeFi enthusiast, it is important to recognize that you are part of an ongoing experiment, and things can go wrong, even with a top-of-the-range audit.
Indeed, the mark of a successful project is how well it identifies and fixes issues. Most, if not all, have come back stronger.