A short definition for Decentralized Finance, or DeFi, is the ecosystem of financial applications developed with blockchain technology. This means that those applications have no single point of failure, they are decentralized by the provision of blockchain technology’s capabilities. Furthermore, they are inherently open, non-custodial, and transparent.
Let’s explore the moving parts of DeFi and how an average person can understand and take advantage of its practical applications.
Blockchain Smart Contract Protocol: Cronos Chain
Cronos Chain is a decentralized supercomputer where developers can program smart contracts and build applications. A smart contract is an automated code that works according to its initial conditions set.
Imagine Cronos Chain as Amazon Web Services, but no one owns it. In the case of Amazon Web Services, a company owns the service and gives permission to the developers in exchange for capital to use their computing capabilities. The payments happen through fiat currency, and the services are being used under a company’s legal name. All are bound to the traditional structure of governments. However, Amazon Web Services can detain any set of users according to their arbitrary rules. They also have to shut down when a government sends them a subpoena following its rules because it is a centralized service that requires the permission of Amazon and the regulations of the state.
In the case of Cronos Chain, there is no owner of the protocol that provides the computation service. The chain is not bound by any jurisdiction because the computing isn’t particularly live in any particular jurisdiction. It is decentralized through the capabilities of blockchain and its resources are orchestrated by a native token. In this case, the token is CRO.
A set of developers regardless of what their identities are (they could be anonymous as well) reach a consensus of what will be the rules are of the protocol. It is like a democratized Amazon Web Services where the stock owners control the protocol through resource allocation and open source development. Furthermore, those stock owners are also pseudo-anonymous entities that govern the Cronos Chain protocol and the state is not easily able to coerce them to take a particular action which makes imposing regulations is harder to implement.
Imagine a smart contract as an intangible vending machine. In the case of a vending machine, you put a dollar in you get one Coca-Cola. In the case of a smart contract, you put a CRO in, you get the token you desired to exchange with. Both are automated and there is no human intervention in the process. What land (where vending machine stands on) is to Vending Machines, Cronos Chain (where smart contracts are developed and implemented in) is to Smart Contracts.
DeFi is an application that consists of smart contracts. So a Decentralized Exchange application built-in Cronos Chain is like a Robinhood Stock Trade application built with Amazon Web Services. It is simply automated for a user to use instantly to get the desired outcome without going through any third parties in the process. If someone sends a particular token for the function of exchanging it with something else, the conditions of the smart contract execute the desired action which results in the intended output without an intermediary.
Web3 Wallet: Metamask
When you need to use an interface of a Web3 application such as a decentralized exchange, the requirement would be using a crypto wallet that functions as a gateway to that applications’ functionalities. Metamask provides users with an entry point into the emerging world of decentralized finance, or DeFi, providing a way to access DeFi apps. In this article, we are going to talk about ChronoSwap.
The application is mainly developed for Ethereum mainnet but it is also compossible with EVM-compatible protocols such as Cronos Chain. It allows users to store and manage account keys (functioning as a banking application) send and receive Cronos Chain-based cryptocurrencies and securely connect to the decentralized applications. It is easy to use and setting up an account takes a couple of minutes with no strings attached. You don’t need your ID, Social Security Number or even your name to be connected to the vast financial applications of the DeFi ecosystem, unlike traditional financeş.
You have full custody of your funds with Metamask. You store your capital in an encrypted browser where no exchange, person, or third party is in control of your funds except you. This brings responsibility to the user because they would be fully accountable for the security of their funds but carrying a swiss bank account in your pocket comes with some accountability. As the saying goes: great power comes great responsibility. However, it is not extremely hard to keep funds secure as long as commonsensical measures are taken.
Decentralized Exchange Application: ChronoSwap
Exchanging tokens through Decentralized Exchanges is pretty straightforward. The execution of the trades happens in a non-custodial manner where traders have full control over their assets without depositing them into a particular third-party application.
When a transaction of trade is initiated, a smart contract instantly swaps the tokens at the same time through one transaction. For example, in the case of Metamask, when you wanted to exchange your USDC tokens with CRO tokens, the time your USDC tokens left your wallet you get the CRO tokens in your custody making entire processes free from third party risk.
This is possible by Automated Market Method technology and liquidity providers.
Adding liquidity into decentralized exchanges is a popularized passive income method for people who would like to utilize the funds they are already holding. This requires an exchange that utilizes Automated Market Method (AMM). The automated market maker method is an algorithm used by renowned decentralized platforms like Uniswap and Sushiswap, in the case of Cronos Chain, ChronoSwap. With AMM, traders don’t need any third party to agree to their transaction terms. They can trade their funds without depositing their capital into a third-party application. AMM-based exchanges do not require traders to wait long to find matching trades. Instead, they can make fast trades using a pool of funds that automatically execute transactions based on certain parameters. AMM markets simply transform peer-to-peer decentralized trading into peer-to-contract trading which is more efficient, faster, and cheaper.
Providing liquidity happens through locking two paired tokens into the smart contract to collect fees of the trades taking place in that particular liquidity pool. We can define a “pool” as the sum of at least two tokens locked in a smart contract. Generally, tokens locked have the same amount of value. For example, if there is a liquidity pool of CRO-USDC, an investor can lock 1000 dollars worth of CRO and 1000 dollars worth of USDC into the liquidity pool. If the whole liquidity pool had 100,000 worth of cryptocurrency, the newcomer investor would have approximately 2 percent of the entire pool. This would allow them to earn 2% of all trades are taking place in that particular liquidity pool minus a small fee for the application that made the system possible.
This is revolutionary because, now, anybody can provide liquidity to decentralized exchanges and earn from the trading fees (instead of centralized exchanges or a particular platform are having all fees are generated in a particular trading pair and reaping all the rewards.)
Farm Pools – Token Distribution
Farming pools are a staking method that is also called yield farming. To yield farm, an investor is going to need LP tokens acquired from providing liquidity to liquidity pools. In layman terms, LP tokens are IOU (I owe you) tokens to be exchanged to get the cryptocurrency back that is provided to liquidity pools. They represent the ownership of the delegated assets into LPs. In farming pools, you can stake those LP tokens to earn additional rewards.
For example, when you provide CRO and USDC to a (CRO-USDC) pool, you will get (CRO-USDC) Liquidity Pools token. Your CRO and USDC are earning from trading fees in the liquidity pool but you also have (CRO-USDC) LP tokens in your wallet that represent the ownership of your assets in the LP. You can also earn from those LP tokens without losing your position in the liquidity pool. So you stake your LP tokens into farm pools and earn additional staking fees.
The question might be, why am I earning additional rewards from tokens that already earn trading fees in Liquidity Pools? It is because the decentralized exchanges want to provide additional incentives to hold you in the liquidity pools for an extended period by offering more rewards. When an investor provides liquidity, they make that exchange functional and more desirable for new traders to come. When investors hold their tokens inside for an extended period, this will make that exchange more reliable and valuable because along with the liquidity, the total value locked in an exchange is a selling point that is impactful to determine that exchange’s quality by signaling popularity, security, and juicy rewards.
Staking pools are the easiest way to earn rewards with ChronoSwap. You stake your CNO tokens into the CNO Pools, in return, the exchange pays you with a varying range of tokens. Exchanges are incentivized to do this because they want to raise the total value locked in their exchange pools as an indicator of quality, demand, and user confidence. They also want to create demand for their native exchange token CNO by providing utility so the price would go up organically.
Understanding the inner workings of the applications users are taking advantage of is important to not miss any opportunities. It is also essential because if the investors are not aware of what they are getting into, they might miscalculate the risk they are taking on. Exchanging tokens, providing liquidity, farming pools, and staking applications are a good use of functionalities DeFi offers. Anybody who is sufficiently informed and who has an internet connection with some funds can capitalize on them.