How to Invest in DeFi: The Ultimate Guide

Decentralized finance technology has progressed over the past couple years. Check out this guide to learn how to invest in DeFi.

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Adam Moelis
Jan 21, 2022
10 min Read

Are you interested in learning how to invest in DeFi?

The DeFi market has exploded over the last couple of years, recently reaching a market cap of over $100 billion.

Thanks to its meteoric rise (and the millionaires it's minted) DeFi has been gaining a lot of attention recently. Besides promising large potential for growth, DeFi is also shaking up traditional finance systems and paving the way for a more egalitarian financial landscape.

At the same time, the DeFi arena is still in its infancy. Therefore it's very important that you get to grips with how DeFi works before getting your skin in the game and investing in DeFi.

If you're wondering what is DeFi, and whether DeFi investments are worthwhile, keep reading.

What Is DeFi?

DeFi stands for "decentralized finance."

When Bitcoin came into being, it became the first decentralized digital currency. People can transact in Bitcoin and other cryptocurrencies without any intermediaries, banks, third parties, government treasuries, etc.

However, while cryptocurrencies were decentralized, exchanges weren't. This gave rise to some of the first decentralized, DeFi exchanges.

Initially, all decentralized exchanges were built using Ethereum smart contracts. Smart contracts are basically pieces of code that facilitate an agreement or protocol.

For instance, let's say you bet that the price of Bitcoin is going to rise $5,000 in under a month, and Joe bets that it won't. You could create a smart contract that will issue a payout to the person who wins the bet.

What DeFi has done is utilize the ability of smart contracts to facilitate contracts to create "hands-free" finance solutions that don't rely on a middleman or centralized third party.

How to Invest in DeFi

Decentralized finance offers a lot of exciting possibilities. Traditional finance has various issues, including low interest rates, high transaction fees, high borrowing fees, long waiting times, lots of red tape, etc.

DeFi is making it possible for anyone to transact, even if they are unbanked, or don't meet the prerequisites that banks and financial institutions require.

Currently, there are over 2 billion unbanked people in the world.

Not only is DeFi showing signs of solving issues like this, but it's also set on a course to make financial transactions quicker, cheaper, and more convenient for just about anyone.

Because of this, DeFi solutions are likely to see continued levels of growth in the future, making it a potentially lucrative investment area to look into.

Curious about how to invest in DeFi?

Here are some of the different ways you can start investing in DeFi.

Hodl DeFi Tokens

If you're new to crypto speak, "hodl" means to hold. One of the most straightforward ways to invest in the DeFi space is by buying a token for a specific decentralized finance project.

Most DeFi projects and platforms have their own token or currency. By buying and holding these tokens you are essentially buying "shares" in the project. If the project or platform is a success and experiences growth, the value of the tokens should rise.

Depending on the adoption levels, some DeFi tokens can achieve significant gains over time.

For instance, Yearn Finance token appreciated in value to the point where it even outstripped Bitcoin in gains back in 2020. At the time of writing, Yearn Finance coin is worth over $31,000.

Buy and Hold Ethereum

If you aren't sure which DeFi coins to invest in, you can also choose to simply buy and hold Ethereum or Binance smart chain tokens. A lot of DeFi projects run on Ethereum smart contracts. By investing in Ethereum as a whole, you can expose yourself to the DeFi space and its potential for growth without having to delve into individual DeFi projects.

Researching individual DeFi projects can take some time and acumen. There is also a higher risk as most DeFi tokens are newer and have less established market caps than a more mature cryptocurrency like Ethereum.

Ethereum has established itself as one of the "Big 5" cryptos and offers a relative level of stability. Even more conservative-minded, non-crypto-focused investors like Graham Stephen are including Ethereum in their portfolios.

Invest in DeFi Index Funds

Another simple way you can start investing in DeFi is by buying into a DeFi index fund. Index funds track the value of an underlying basket of funds or investments.

For instance, the S&P 500 is an index fund of the top 500 largest publicly-traded companies in the states.

There are a variety of different DeFi index funds out there, so it's important to do your research before investing in DeFi index funds.

At the same time index funds inherently come with less risk. If you invest in a reputable DeFi index fund, there's less chance of losing money because you have diversified exposure to a composite of DeFi coins.

Stake Your Crypto

Another way to invest in DeFi is by staking DeFi tokens.

Some blockchains run on a proof of stake transaction protocol. Instead of miners using electricity and computing power to confirm transactions on the network, holders can stake their coins. Staked coins work to confirm transactions, thereby running and securing the network.

If you stake your coins, you will receive a staking reward, which is the equivalent of mining rewards.

This is an easy way to earn "interest" while holding a DeFi token.

Take note, not all DeFi protocols work on the proof of stake confirmation system. If you want to start investing in DeFi and maximize your return on investment via staking, you'll have to invest in a DeFi project that works on proof of stake.

Provide Liquidity to Decentralized Exchanges

If you're wondering how to invest in DeFi, another option is to provide liquidity to decentralized exchanges. Decentralized exchanges require a liquidity pool to facilitate transactions for users.

You can provide liquidity with various cryptocurrencies, including DeFi tokens and stablecoins.

If you are holding certain cryptocurrencies or tokens, you can stake them as liquidity for a decentralized exchange like Uniswap. A smart contract will lock the coins or tokens for a certain period, during which you will earn fees at a percentage rate to the amount you staked.

This might sound like a risky thing to do, considering your holdings will be locked in by a smart contract. However, if you pick a large DeFi exchange, you should enjoy a certain level of security.

Now you might be wondering, how big are DeFi exchanges anyway? In 2020, Uniswap surpassed Coinbase in exchange volume.

That said, it's always a good idea to weigh your options when investing in DeFi. There are a lot of opportunities out there, but recent reports have revealed that staking liquidity to DeFi exchanges like Uniswap could result in impermanent losses.

Impermanent losses can take place when the value or ratio of the tokens you have staked drops or changes during the time it's locked in the smart contract. If the loss is more than the fees you have earned from staking, you might have been better off holding rather than staking.

Lending Out Crypto via DeFi Platforms

Another way you can invest in DeFi and earn interest is by lending tokens to other crypto users via a DeFi lending platform such as Aave.

DeFi lending platforms are changing up the game for cryptocurrency holders who want to access a loan without going through a traditional bank or lender. DeFi lending platforms allow users to pledge cryptocurrency holdings as collateral for loans. Loans are typically overcollateralized, meaning users must pledge more crypto than what they can borrow.

This helps protect against sudden price swings that might render the collateral value to be less than the loan, which would incentivize borrowers to abandon their collateral and not repay the loan.

The exact ratio of collateral to loan value depends on the cryptocurrencies involved. More volatile cryptocurrencies (or ones with smaller market caps) tend to require a higher ratio of collateral.

If you have a stash of crypto and want to earn interest on it, you can deposit your tokens in a platform like Aave and let them work for you. Depending on the cryptocurrencies you deposit, you can earn relatively attractive rates of interest.

Take Advantage of the Yotta DeFi Bucket

If you are a Yotta user, and interested in learning how to invest in DeFi, we have an easy, secure way for you to get started.

All you have to do is move some money into the Yotta DeFi savings bucket. We will automatically convert it into stablecoins and put it to work in the DeFi markets. You will earn a 4% average APY, plus 2.5x the Yotta tickets.

If you want to convert back to USD, you can do so within 24 hours, without incurring any fees.

In short, you get crypto-level returns, but with dollar stability, and zero learning curves, risks, gas, or fees.

Things to Think About When Investing in DeFi

As you can see, there are various ways you can make money in the DeFi ecosystem. Besides investing in DeFi tokens themselves, you can also pledge and stake cryptocurrency tokens to earn interest and confirmation rewards.

However, before you jump in and make your first DeFi investments, it's important to understand as much as you can about the associated risks.

If you're still learning how to invest in DeFi, our advice would be to take things slow and educate yourself along the way to make sure you don't lose money. Investing for beginners can be confusing enough in the traditional money system. Crypto and DeFi come with their own learning curves around security and risk.

Your Money Is Not Guaranteed

The first thing to always remember when learning how to invest in DeFi and cryptocurrencies is that your money is not guaranteed.

Most traditional, centralized, financial institutions insure deposits with the Federal Deposit Insurance Corporation (FDIC). For example, here at Yotta, your deposits are eligible for pass-through FDIC insurance up to $250,000.

Yotta also has various security features in place, such as 2FA, Instant Lock Card, biometric authorization, and more. These help ensure that your money can never get stolen by a third party.

With cryptocurrencies and DeFi platforms, there is no insurance on your money. If your holdings go missing in a scam or a hack, there's no guarantee you'll be paid back.

If you want an extra level of security, you can opt to insure your holdings through a DeFi insurance platform like Nexus Mutual.

Hacks and Bugs Aren’t Unheard Of

Depositing your holdings into a DeFi platform comes with an increased level of risk, as it's no longer in your own wallet. If the platform gets hacked, there is a chance that you might lose your cryptocurrency savings.

Hacks and bugs, although relatively rare, are not unheard of in the space. The best way to protect yourself is to invest in DeFi projects that have an established track record, have been audited, and have a larger market cap.

Rug Pulls Happen Frequently

Another thing to be aware of if you're investing in DeFi is that rug pulls happen regularly. Rug pulls are sometimes done by the creators of a project, and sometimes by outside hijackers.

The best way to avoid rugs pulls is to research projects thoroughly and choose DeFi investments that have been around for a while and have been audited.

Investing in brand new projects can give you the most potential for gains, but it also exposes you to far more risk.

Crypto Is a Volatile Market

Crypto is still a volatile market, and DeFi investments are no exception. Therefore, always factor in the chance of sharp price fluctuations, especially for things like providing liquidity.

One of the best investing tips to follow for volatile markets is also to never invest more than you can afford to lose.

You Are Responsible for the Safekeeping of Your DeFi Investments

Lastly, keep in mind that you and you alone are responsible for the safekeeping of your DeFi investments.

If you're new to buying and holding cryptocurrencies, then you will need to read up on crypto ownership, storage, and investing for beginners.

Educating yourself on how to safeguard your wallet and private keys is an essential part of learning how to invest in DeFi and keeping your investments safe.

Do You Want a Risk-Free Way to Start Investing in DeFi?

Now you know the basics of how to invest in DeFi. However, keep in mind that the DeFi landscape is a complex space. DeFi investing for beginners can quite daunting, especially if you're new to storing and managing cryptocurrencies.

This is why here at Yotta, we decided to create DeFi buckets for our users. DeFi is an exciting area and is bringing about a lot of positive change.

Yotta's DeFi buckets allow you to invest in DeFi and enjoy some of its attractive returns, without placing your money at risk.

If you haven't already, sign up for a Yotta account, and start saving and investing in DeFi the safe, fun way.

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