Decentralized finance (DeFi) continues to soar since the start of “DeFi Summer” in 2020. However, for those just learning about this sector, even the basic concept of tokens can seem complicated.
Previously, most new entrants to the crypto sector arrived via Bitcoin. Now, with the growth of NFTs and crypto memes, people’s immersion in the sector is through other channels.
Sure, the boom that DeFi has experienced has helped with crypto adoption, but it hasn’t exactly made things simpler. Indeed, a person taking their first steps into crypto may grasp the idea of buying a piece of art or holding a Shiba Inu coin, but they may not immediately understand the real purpose of these tokens.
Far more than just hyper-mediated crypto-currencies, DeFi tokens are an important source of value creation. Their holders can use them for their investments, to participate in the governance of protocols, and even as collateral for loans. Indeed, these tokens are created by projects to achieve specific goals.
Deciphering how DeFi tokens are used
First of all, you should know that decentralized finance tokens are different from other cryptocurrencies. For example, Bitcoin, which has been around for years, has only recently begun to build its ecosystem. On the other hand, DeFi, which is much newer than Bitcoin, is already used every day in financial services.
Indeed, DeFi tokens are not a simple means of exchanging goods and services, and this is where their complexity comes from.
Governance in decentralized finance
Since the goal of decentralized finance is to offer an alternative to traditional financial systems, rules must be established. These rules will allow DeFi projects to make important decisions about protocol changes.
For this reason, governance relies on a set of rules and operations to regulate all network actions.
The advantage of DeFi is that financial assets are accessible without the need for intermediaries or paperwork. This allows token holders to obtain collateral-backed loans, as they themselves contribute to the liquidity of the platform.
Speculative investment is another option offered by tokens. Indeed, people buy and hold tokens because they expect them to gain in value. However, as with all other cryptocurrencies, there are risks associated with this asset holding. From volatility to security breaches, DeFi protocols are not immune to vulnerabilities.
In practical terms, staking involves “locking up” a portion of one’s cryptocurrency holdings for a set period of time. It is a way to contribute to the blockchain network.
Holders of staked tokens receive rewards, often in the form of additional tokens. In a nutshell, crypto staking is quite similar to depositing money in a bank. The mechanism is simple: the depositor “locks” his funds and receives rewards in return.
The most popular DeFi tokens
Currently, there are 214 DeFi tokens to choose from, each with its own characteristics. Here are some of the most popular platforms and their tokens.
AAVE: 16,000,000 AAVE
Aave is one of the most popular DeFi platforms right now and its native token is LEND. This liquidity protocol allows users to earn interest on their deposits or borrow assets. In addition, they can benefit from reduced fees and have the opportunity to later participate in the governance of the protocol.
Indeed, users can engage either as borrowers or depositors. The platform deposits users’ funds into a non-depository smart contract housed on the Ethereum blockchain (ETH).
yEarn: 30,000 YFI
The yEarn protocol acts as an automated yield aggregator governed by the native token, YFI. It offers various yield farming opportunities. To participate in governance, holders must place their YFI tokens in staking. This will allow them to claim a pro-rata share of the platform fees.
Ren Protocol: 1,000,000,000 REN
The Ren Protocol transfers assets to Ethereum using the RenVM network. It also provides a decentralized, permissionless virtual machine. In order to host a dark node on the protocol, users must offer 100,000 REN as collateral. After giving this guarantee, users begin to receive a pro rata share of the platform’s trading fees. Ren allows tokens to be wrapped in ERC-20, which makes it easier for DeFi platforms to support them.
Uniswap: 1,000,000,000 UNI
Uniswap is the leader in decentralized DeFi exchanges. Its native token UNI is based on the Ethereum blockchain. In the beginning, users were given UNI tokens for participating in the exchange. Today, those with a significant number of tokens can vote on the various policies offered on the Uniswap platform. UNI has a market capitalization of over $18 billion, making it one of the most valuable DeFi tokens.
Not all DeFi tokens are created equal
As with any other profitable sector, DeFi is not immune to scams and problems.
“The majority of DeFi tokens are worthless. Most are not tied to the cash flow generated by the project, and the ‘value’ they offer often pays you with more worthless tokens,” says Red, community manager at Harvest Finance.
“It’s important to watch what happens to these projects after their initial wave of hype. Those looking for cash rush to the rewards and then move on, leaving behind overvalued tokens and a project with zero viability,” he continued.
However, this isn’t a problem specific to DeFi. Red compared the situation to the current hype surrounding NFTs.
“There may be value in a small percentage of NFTs, but most of the NFTs we see now are just variations of “pet photos” with no utility, and people are hoping to cash in on the hype surrounding them,” he pointed out.
So those new to the DeFi industry really need to consider the full range of projects they are interested in. Most legitimate projects, which have real value tokens, also have well-built communities around them.
It is through these decentralized communities that one can assess the value of a DeFi project and its token. A strong community proves that there is a human commitment to the project, not just a hype around a token.