Beginners Guide to Investing in DeFi 101: ICO, Coin Offerings, and Staking
Decentralized finance (DeFi) is relatively new to the crypto industry, and is made possible by smart contracts on Ethereum’s network. Although DeFi primarily serves in the lending and trading sectors, the industry is growing at a tremendous rate. This makes investing in DeFi tokens now a great potential investment opportunity for the long term.
The last couple of years have seen some of the most significant progression of decentralized finance technology, with its market cap surpassing the $100 billion mark. Nevertheless, a horde of people that are looking to invest in DeFi often do not know where to start. Here is a beginner’s guide to the background of crypto, what it is, and how you can take advantage of the increasingly reputable DeFi investment options.
Background of Decentralized Finance
To be able to effectively invest in DeFi, it is essential to understand the background of cryptocurrencies. Bitcoin was the first decentralized digital currency to be introduced in the crypto market. Decentralized currencies allow people to transact without the need for banks, government treasuries, third parties and other intermediaries.
While cryptocurrencies were decentralized, financial exchanges weren’t. This necessitated the establishment of decentralized financial systems (DeFi). However, decentralized systems never came to life until Ethereum smart contracts were introduced. Smart contracts introduced code that could facilitate agreements and protocols without the need for third parties.
DeFi utilizes the ability of smart contracts to create decentralized financial solutions to exclude middlemen and centralized third parties. As a result, decentralized finance has created a myriad of lucrative investment opportunities without the disadvantages of traditional finance such as low interest rates, high borrowing fees, plenty of red lines, long waiting times, and high transaction fees. More and more unbanked people continue to stream into the exciting investment opportunities of decentralized finance.
Some of the most exciting investment opportunities in DeFi include;
1. Initial Coin Offering (ICO)
An initial coin offering (ICO) is a way for companies in the cryptocurrency industry to raise funds to create a new crypto coin, app, or service. ICOs are very similar to IPOs. However, interested investors receive a new cryptocurrency token from the company after buying into an ICO. The coins can have utility for a software product or service.
Numerous ICO investors have gained massive returns from their investments. However, many others have fallen victim to fraudulent offerings or have made little to no returns after the ICO performed poorly. It is, therefore, advisable to be coherent with the basic mechanisms of cryptocurrency wallets and exchanges and purchase a more established digital currency when kicking off your ICO investment.
To a large extent, ICOs are unregulated, which calls for a high degree of restraint and caution on the part of the investor when investing in ICOs. However, ICOs are undeniably incredulous innovations in fundraising possibilities. Nonetheless, due to their several drawbacks, they are succeeded by the Initial Exchange Offering (IEO) system.
2. Initial Exchange Offering (IEO)
With the several drawbacks of ICO evident in 2017, progress became increasingly difficult for ICOs in consecutive years, almost crawling into a complete halt by the end of 2018. With numerous ICOs failing, IEOs (Initial Exchange Offering) were introduced in 2019, bringing more liquidity and trust in crowdfunding processes.
Being the next evolution of ICOs, IEOs introduce exchanges as a trustworthy middleman. Unlike in ICOs, token sales in IEOs are conducted on an exchange platform or ‘launchpad’. The exchange platform is responsible for due diligence for listed projects and the KYC/AML on the investors.
One of the most significant advantages of IEOs over ICOs for investors is the reduced chances of investing in under-qualified projects. Moreover, tokens are listed on the exchange automatically after the crowdsale, offering investors immediate liquidity.
3. Security Token Offering (STO)
A Security Token Offering (STO) is similar to ICO. However, STO-issued security tokens are linked to tangible assets such as company shares and real estate trusts (REIT). STOs, therefore, qualify as investment contracts and are governed by existing securities regulations. One of the best ways to distinguish between securities and utility tokens is using the Howey Test. The test inspects an investment’s substance to determine whether it qualifies as an investment contract.
STOs allow users to trade autonomous traditional financial assets on blockchain, which operates 24/7. The interoperability between cryptocurrencies and traditional financial assets offers lucrative investment options for the users. Moreover, STOs continue to be gradually adopted by companies as it offers a transitional bridge from conventional financial systems into the open financial world.
4. DeFi Staking
DeFi staking is the temporary commitment of crypto assets with the aim of becoming a validator in a DeFi protocol or a layer-1 blockchain. Staking crypto assets in this case refers to locking fungible or non-fungible tokens into smart contracts. Furthermore, the user earns rewards whenever their stake is utilized on the platform.
The original form of DeFi staking requires a user to lock a specific amount of coins or tokens to become a PoS (proof-of-stake) validator on a blockchain network. The PoW consensus algorithms originally utilized by most blockchain networks require high computing power to validate transactions, leaving a larger carbon footprint. The PoS system rely on validators with a vested interest in the blockchain network, as they are more inclined to perform their duties diligently and avoid losing their stake. Additional staking rewards are designed to encourage validators to generate and validate blocks.
Nevertheless, the DeFi staking process may be out of reach for smaller investors, as it often necessitates that the user posts a relatively high bond. Fortunately, several staking providers came up with “staking pools” –a solution that allows users to form larger groups and post the bond together, allowing even the smaller investors to participate in DeFi staking. Staking pools are also currently available through various centralized as well as decentralized finance exchange systems.
The benefits of DeFi staking vary between the PoW and PoS systems. For instance, the most significant benefit of PoS chains is security and lower environmental impact. Some of the benefits of DeFi staking for the user include:
- A low entry fee
- An easy way of earning passive income
- It is pretty straightforward to get started
- Rewards are often higher than most investors expect
- High security when proper smart contract protocols are followed
It would be true to say that DeFi has opened the gateway to a decentralized and autonomous financial system for companies and investors across the globe. Nevertheless, there is still a lot of work to be done. All said and done, it is one of the most opportune times to integrate DeFi systems and invest in DeFi through the various methods available. Hop onto our website to familiarize yourself with the fundamentals of DeFi systems and the best tokens to invest in.