What is DeFi?: Part 2

Introduction

This post highlights consensus algorithms, Cardano’s Ouroboros, liquidity, and impermanent loss. To read the part of the post that highlights the importance of DeFi, Smart Contracts, and NFTs,?click?https://link.medium.com/iq01lPaZXkb

The different Consensus Algorithms

Before we deep dive into the different consensus systems, let’s explain the need for a consensus system. Cryptocurrencies focus on removing the need for any central authority. The question is, how do we coordinate financial activities without a central party? To achieve that, a new methodology was introduced called — consensus algorithm. The consensus here means that most of the participants agree on the single version of the truth at a given time. So what are the consensus systems we have in the crypto world?

Proof-of-Work (PoW)

Proof of Work is the first consensus system to hit Cryptocurrency work. A consensus system validates and records transactions on the Blockchain by making computer nodes compete to generate cryptographic hashes that satisfy a network-determined level of complexity. The complexity level is set too high to prevent any attack on the network. This act requires a lot of computing power that is expensive and consumes lots of electricity. Miners receive a reward for solving complex mathematical problems and verifying transactions on the Blockchain.

PoW’s biggest challenge was scalability. For the network to handle more users and increase functionality, its processing power must increase. Hence, PoW started being criticized for not being environmentally friendly. Next, mining started becoming exclusive. Compared to the beginning when anyone could mine Bitcoin, at the moment, only a cluster of large mining pools can mine Bitcoin using the fastest and most sophisticated mining hardware.

Proof-of-Stake (PoS)

The criticism of PoW led to the introduction of PoS. PoS was designed as a more efficient alternative to PoW. Rather than using computing power, an algorithm chooses nodes that record transactions on the Blockchain. The algorithm assesses how much cryptocurrency the node’s owner holds, and the more significant the amount, the more likely they’ll be chosen to process and record the transaction.

In other words, the node with more “stake” in the crypto is more likely to be chosen.

Next DPoS

An upgrade to the PoS system is the DPoS. DPoS stands for Delegated Proof of Stake. It works just like PoS but with a twist. DPoS features a voting and delegation mechanism that makes the process more democratic. DPoS is based on earned reputation and not overall wealth.

Delegated Proof of Stake (DPoS) is a popular evolution of the PoS concept, whereby users of the network vote and elect delegates to validate the next block. Delegates are also called witnesses or block producers. Using DPoS, you can vote on delegates by pooling your tokens into a staking pool and linking those to a particular delegate. You do not physically transfer your tokens to another wallet but instead, utilize a staking service provider to stake your tokens in a staking pool. Platforms like Steem, EOS, and BitShares use a DPoS system.

But wait, there’s more…?Ouroboros.

Many people often confuse the DPoS with Cardano’s Ouroboros. Ouroboros is a type of PoS, but that doesn’t make it DPoS. Cardano developers have highlighted that Ouroboros is new, innovative, and different DPoS. Ouroboros is a consensus mechanism based on scientific, peer-reviewed philosophy which utilizes Proof-of-Stake (PoS) to achieve the same security guarantees as Bitcoin.

What Makes Cardano’s Ouroboros Special

Ouroboros is the first PoS protocol that has mathematically been shown to be provably secure. In Ouroboros, nodes are pooled into staking pools because one node might not have sufficient expertise to deliver new blocks. Staking pools are chosen randomly by the Ouroboros algorithm to create new blocks based on the weight of their stake.

Delegating your stake to a pool does not put your ADA at risk. Ouroboros does not require you to send, lock up, or freeze ADA in any way. Also, there is no minimum or maximum stake, and there is no limit to when you can add or remove your ADA from your wallet.

One clear-cut difference between Ouroboros and DPoS is that Ouroboros chooses the densest chain or one with the most validators and transactions, but DPoS selects the longest chain. It is important to note that ADA can also be staked from any wallet, including hardware wallets and paper wallets.

Investing in DeFi

There are many ways to invest in DeFi. We will be highlighting a few now and more to come later on our blog surehive.io/blog

1.?Lending and Borrowing

Lending is one of the easiest ways to invest in DeFi. Here you act as a bank. You provide funds for repayment and profit in the nearest future. On the other hand, Borrowing means you are the one asking for funds.

The process for Borrowing is simple. The protocols that allow for Borrowing require the borrower to provide collateral. This collateral is locked into the protocol and is not released until the borrower pays back what they owe with interest. If the borrower cannot pay, a portion of the collateral is released to the lender through liquidation.

Some protocols pay users to borrow assets. This is common with new protocols that try to attract users to their platform by offering rewards for all transactions. Some pay up to 3% of what users borrow from them with their local tokens.

2.?Providing liquidity

Traders are conversant with Market Makers (MM). To make transactions efficient, a Market Maker has to provide liquidity so that smaller players can easily exchange currencies with one another. Market Makers make their money from the spread (entry fee you pay for entering any trade) from the smaller players.

In a normal Cryptocurrency setting, many of the exchanges are centralized, which means assets can still be hacked and stolen. With DeFi, the exchanges are decentralized, and exchanging assets can be done without giving up control of their keys. This is where the liquidity pools come in.

A liquidity pool refers to a large decentralized pool of assets that act as market makers. Instead of being controlled by individuals, companies, or institutions, liquidity pools are governed by smart contracts to regulate the pairing of assets.

So how do you generate yield by providing liquidity?

Liquidity pools work just like lending and Borrowing but with a better reward. One can start by transferring assets to a protocol, and you receive the Liquidity Pool token of that protocol in return. Every time someone carries out any exchange on the protocol, Liquidity Providers earn up to 0.3% of the Liquidity Pool token transacted.

Pro tip: You must have heard of many traders making huge profits on DeFi. You must understand that identifying profitable cryptocurrencies and capitalizing on opportunities is a learned skill.

This is a long-term investment option. You must consider many things before taking up this option — it is called fundamental analysis.

Fundamental analysis lets you know if a cryptocurrency has the right attributes for success over your desired investment timeframe. To do this, you have to consider several options like tokenomics, team experience, partnerships, roadmap, market sentiment, and more. Knowing this helps you determine if it is overvalued, undervalued, or perfect. Once you are done with your analysis, you can add the asset to your portfolio. To make smart decisions about what to invest and where to invest, you should consider Surehive.io.?Surehive?is a sure bet when it comes to performing fundamental analysis. The team behind?Surehive?is remarkable. The protocol features a profit and loss dashboard to perform all your analysis without leaving the protocol. The protocol allows you to swap, borrow, lend, perform yield farming and all forms of fundamental analysis without leaving the protocol. Fun fact about the protocol, it has its in-built non-custodial wallet.

Pro tip: It is essential to double-check wallet addresses and website addresses (URL). Do not click on a link from an email or any social media platform. DO NOT enter seed phrases again if prompted unless you are 100% sure of what you are doing.

Difference between APR and APY

A quick rundown of the similarity between these two is that they both measure interest over time.

APR stands for Annual Percentage Rate. It refers to the percentage of interest an investor or depositor earns over a year. So let’s say you invested $100 at an APR of 20%. At the end of your agreement, you should have $120

APY stands for Annual Percentage Yield. It is similar to APR. The difference is that APY is accumulated (makes use of compound interest), so instead of waiting till the end of your contract to get your profit, your profit comes in regularly (maybe daily, weekly, or monthly). And it reinvests your profit for you until the end of your contract.

Presently when compared to the traditional system where interest rates keep dropping, in DeFi, you can have an APY of up to 200%

Pro tip: DeFi protocols keep hitting the roof with impressive APY rates. Always look out for the APY…The higher the APY, the more interest you could earn.

How to identify Overestimated Coins

Loads of inflated coins have infiltrated the market, and of course, they will never tell you they are inflated coins. So here is the first thing you need to know — what is an inflated or overestimated coin? An overestimated coin is a coin that gets way more exposure than it deserves because it has. If you don’t understand a coin or can’t find its use case, you might want to skip it.

Pro tip: The fact remains that a great coin can have a 90% plunge and still bounce back as long as the community behind it is strong, the facts are clear, and developers always come clean.

Avoiding the Loss in?Impermanent Loss

LPs provide the same value for both tokens in an exchange (DEX) for a share in the pool for a liquidity pool to function correctly. When the price of one token goes up compared to the other, the most expensive token is sold for the less expensive token to create a balance.

Putting it into perspective, let’s say you have 100 plates (50 blue and 50 white) in a basket that people can trade and exchange at any time. Then, a story comes out that white plates are the best, and they bring good luck. Suddenly the demand and price of white plates increases, but the cost of blue plates remains. Due to this, people start getting their blue plates to exchange for white plates.

Four or five blue plates are to be exchanged for one white plate. If you sell your basket at that point, you will sell at a loss since what you have is not of interest to the traders. But, if you wait a little longer, people might start showing interest in blue plates, which may increase demand, and you can avoid any loss.

The Role of Surehive in all these.

Impermanent loss describes the temporary loss of funds occasionally experienced by liquidity providers due to volatility in a trading pair. Liquidity providers are unaware that their liquidity is at an impermanent loss until the point of withdrawal from the pool.

So they are left with two options, accept the loss and withdraw or wait till forever, praying for things to change. Or there is a third option — Surehive.

Surehive aims to reduce impermanent loss. It is transparent to the liquidity provider by providing real-time profit-loss analysis and portfolio updates through targeted email and social media notifications.

DeFi Exchange (DEX) has its downsides, including slippage, front-running, sandwich attacks, and trade failures. Front running refers to the practice of trading based on information about future trades contained in a blockchain’s transaction queue in cryptocurrency markets. Slippage refers to the difference between the price expected when the trader submits a swap transaction and the price at which the transaction is confirmed on the Blockchain.

Pro tip:?An estimated 5% of Ethereum-based exchanges fail due to too much slippage and low gas prices. Also, of the 1.1 million transactions made on Uniswap between April 15th and April 21st, 241,262 failed. Another research showed that 12.6% of billionaire investor Mark Cuban’s Ethereum transactions had failed, despite spending nearly $12,000 on gas fees alone.

Surehive implements a Constant Ellipse Automated Market Maker (CEAMM) on Cardano to minimize front-running and reduce slippage. The Cardano environment is unique in handling fees, as fees do not go directly to the block producer. Instead, they are pooled and distributed to all pools that created blocks during an epoch. This process of implementing fee rewards discourages front-runners from abusing the system.

Also, high trading fees are prevalent with DeFi transactions since most of these transactions take place on the Ethereum Blockchain. Subsequently, our future posts will talk about gas fees, but the fact remains that transaction fees are on the rise now. A simple transaction can cost up to $20, and a complicated transaction can cost up to $200 depending on the current usage of the Blockchain.

Pro tip: Do not underestimate gas fees. This is the number one mistake most newbies make in DeFi….in essence, always calculate your gas fees first.

Surehive is built to be a first-class citizen of the Cardano blockchain in solving this problem. Cardano enables high transactions but with low fees, thanks to Ouroboros — Cardano’s PoS consensus mechanism.

Conclusion

DeFi is broad, entertaining, and evolving. Cryptocurrencies brought about a better financial system, but DeFi makes it better. DeFi has democratized the financial system with 24/7 access to how money is made, spent, saved, and invested. Asides from that, it comes with a better yield than any financial system has ever had to offer, removing bureaucracies and intermediaries.

But, at the moment, only those who are fluent in the world know how to be strategic with DeFi. We will be highlighting this (how to be strategic with DeFi) and more on our website and other social media platforms. Be sure to follow us on our other platforms.

Telegram:?https://t.me/surehive

Twitter:?https://twitter.com/surehive

Medium:?https://surehive.medium.com

Discord:?https://discord.gg/j3B6JgmmDU

More About Surehive

Surehive is an end-to-end solution that enables users to perform all DeFi activities without exiting the platform. It is set to lead the DeFi ecosystem by providing a friendly user experience, bringing simplicity and reliability in a total package, and an efficient product that focuses on creating seamless and smooth DeFi experiences without compromising the high-security measure.