NONE OF THIS IS INVESTING ADVICE!

If you stick with an investment project long enough, in time, you can make profits. And some projects do offer legitimate value and profit potential. This is not a reflection of the entire DeFi market.

This guide is about highlighting how DeFi projects work on the Ethereum network, and some of the roadblocks for an investor's maneuverability.

Here is the most comprehensive DeCentralized Finance Guide on the internet. Part 1.

I got so fed up with the half ass-ed guides and lack of detailed information, that I'm making my own guide.

Since there is so much information to be unpacked, I'm splitting the guide up into parts.

So let's begin with the basics of DeCentralized Finance. What it is, what forms it can take, and how you can interact with it, and the potential outcomes.

DeCentralized Finance is basically taking financial instruments and vehicles in traditional finance, and executing them on the blockchain usually involving some interaction[s] with smart contracts. You can research the mechanics of it on a technical level, but this is more of a layman's guide.

Let's take a simple example of a traditional investment vehicle on the blockchain: stocks.

Most DeFi platforms (the trustworthy ones anyway) behave very similar to stocks. The difference being, you're buying a project X token instead of a stock.

Let's create a random platform in the Ethereum DeFi ecosystem. Let's call it DeFi Project X. The first step to getting involved is usually (but not always) swapping some ethereum for Project X token1. So, in that regard, you are at the mercy of Project X's token 1 price whilst your investment is taking place. What projects refer to as "tokens" can most closely be associated with a stock. As long as the value of the project goes up, your token, or stock in the project appreciates as well. And this is not an over simplification, its a fact. Token 1s value is directly linked the total value locked into the project. The same way a stock's worth is the total assets owned by a corporation minus its liabilities divided by outstanding shares. Same thing.

On top, most DeFi platforms offer rewards or APY for those who are willing to "stake" their tokens within a smart contract inside the DeFi project. Building up on Project X, you can take your Project X token 1s, and stake them into a DeFi APY smart yield contract. Some projects offer 4% (more established and safer bets) and some offer 1400% APY. Please note, nearly all DeFi projects that state a specific "APY", doesn't mean the APYs are constant. The APY can show 300% when everyone is exchanging ethereum into Project X because you are getting a piece of the swapping / staking fees associated with entering into a staking project. And not from providing liquidity either (more on this in the later parts of this guide). However, once the FOMO subsides and everyone who can possibly enter has entered, the APY will go down to single digits. So, most often the APY associated with most DeFi projects are variable and change weekly, daily, and even hourly. It all depends on what the DeFi project is trying to do and its appeal to investors. 

When you stake your Token X into Project X's DeFi staking contract, it is locked, until you unstake. For this, you're somtimes given another token, which represents the amount of your investment. We can call this Project X Token 2. So for every Project X Token 1 you stake, you are give a placeholder of Project X Token 2 (again, this may or may not be the case, sometimes you just stake as is). Project X Token 2 is a representation of your staking or Project X Token 1. And for every project X token 2 you own, you are usually paid out a payment of Token 1s in proportion to your investment amount relative to the total amount invested in the pool. So if you stake 10% of a project whose total worth is 1,000,000, then you have invested 100,000.  You therefore get 10% of the entire profits generated from the pool on a specific pay out date (referred to as emission or epoch in DeFi jargon).

Now let's say you purchased or swapped, Ethereum into Token X at $10 a share. You purchased 10 Project X Token 1s. That's $100 investment total. Now you took your Project X Token one, and staked it into an earning pool inside Project Xs page. You are now given 10 Project X token 2s. The total value is still $100. Now lets say a week from now, Project X's Token 1s value drops by 50%. Now you initial investment is worth $50. While your tokens are locked, DeFi platforms, they refer to this as "impermanent losses / gains". Because until you actually, unstake your Project X Tokens 2s back into Project X Tokens 1s, and then sell those tokens for Ethereum, you haven't really lost yet since the price of Project X Token 1s can rebound. In the traditional world of finance,  this is know as "unrealized gains or losses."

Now here is the the kicker. Ethereum gas fees.

So let's run through a hypothetical transaction of interacting on anything inside Ethereum.

The most basic Ethereum transaction is sending and receiving ethereum or ethereum tokens.

For each transaction you need to pay in gas. Now there are two parts to gas. the price per unit of gas, and the gas itself.

For your car, you pay $2.50 per gallon, and you fill up for 10 gallons. That 25.00

With Ethereum, you pay gwei, and the amount of gas you're willing to spend.

Most basic ETH transactions cost 21,000 gas at X price Gwei.

As of this writing gwei is 111 gwei. So a basic Ethereum transaction can cost $5+. Let that sink in.

Now getting back to our DeFi project X, I'm going to list the process for each step, and associated gas fees.

Step 1: Transfer Ethereum from exchange or from mining into your wallet $5+ (assuming gas fees stay in lower 100's)

Step 2: Approve Ethereum on DeFi exchange for swapping into Project X Token 1, you pay gas (only need to approve once, and every other interaction, we skip to step 3)

Step 3: Swap the ETH to Defi Project X Token 1 (you pay gas again)

By this point, you've accumulated roughly 25-30 in gas fees. This does not include the swap fee which hovers around 3-4% on Uniswap.

So if you're exchanging $100 worth of ETH from our example, you're paying $3-4 for swap fees ontop of ETH gas fees.

We're up to $28-34 dollars thus far. On a $100 dollar investment, in just fees. (again, assuming gas prices hover in 100's, if you look at my first blog post, you'll see it hit 900+ recently).

Now let's take it to part two of DeFi projects - staking. 

Step 4: Approve Project X Token 1 for staking and pay gas fess (again done only once, after first time, we skip to step 5).

Step 5: Stake Project X token 1 (gas fees)

There you've done it, you're finally ready to start earning interest on your investment.

To clarify, approving tokens on exchanges and DeFi platforms are a one time fee. But remember, it is a one time fee for every token and exchange. So if I approve Project X token 1s on Uniswap, I will be approving them for Uniswap only, and for Token 1 only. If I want to approve tokens for a different project on Uniswap, I'll have to approve the new token[s]. Or if I want to approve Project X Token 1 on 1inch exchange, that is another approval. This is how exchanges get people to stay tied up in their ecosystem. What we refer to as "sunk costs."

Finally I will point out, the gas fees are the same whether you invest $1,000,000 or $100. 

This is why whales have such an upper hand in the DeFi ecosystem. For them, $100-$1000 in gas fees is nothing because their piece of the staking pie is huge. Your measly $10,000 will net you .01-.001% depending on how much money in total is locked into the the project.

Getting back to my previous article, here is the major downfall of DeFi.  A whale will invest 10,000,000+ into a project and get most of the APY rewards, he will then turn around and dump the original Porject X Token 1's in exchange to cash out. He made his profits. Thousands if not hundreds of thousands. And guess what? the value of your original Project X Tokens 1s still tied up in the staking platform will now be worth X% less than before. He literally sucked the capital out of your tokens into ETH.

But you can't get out. Because now, the price of Project X token 1 is significantly less than when you entered the staking pool. And if you do unstake, and sell. You'll have to pay gas fees for 1)unstaking, 2)selling coins back into ETH amd the swap fees associated with the transaction. So most investors, stay in the pool until the price of Project X Token 1 rebounds. Granted, they're also earning Project X Token 1s (or some form of interest, not always native token itself) while waiting, but as said previously, the amount of the pool which they own is usually very low. So they're usually in the red until the price of the token goes back up (sometimes it never does).

Now do you see why I have an issue ethereum projects? It makes it almost impossible to maneuver quickly when needed. Ethereum and all of DeFi was supposed to be about empowering investors and facilitating transactions with low fees. This is in my view, the direct antithesis of what crypto began as. As a small investor, you are almost guaranteed to lose money initially unless you're willing to sit in a project for months. Mind you, the staking spiral can go in infinitely. Some places allow you to stake Project X Token 2s into another yield farm where you receive Project X Token 3s. It can go on endlessly with all of it compounding interest, and gas fees along the way.

And that's fine, as long as the original token value is steady, but they're not.

While everyone is yelling about the merits of DeFi projects and profitability, I have seen far too many people losing their hard earned cash to what really equates to, a ponzi scheme. Each sucker which enters is giving APY back to the previous sucker who entered before. All the while, the original investors and project leaders are the ones getting rich because they bought into Token X when it was pennies.... On top of our whales of course.

Speaking of early investors and developers, they too are awarded a sizable chunk of tokens as part of their efforts. And usually, once a token's price reaches a certain point, or time, or both, they sell. Sound familiar? it should - stock options. Investment banks can't sell shares of an IPO right after it goes public, but after a certain time or price, they usually dump them. And since they got in super early, and cheap, they make millions. You lose as the price collapses after the dump.

Is any of this sounding familiar? Big bucks making more big bucks at the expense of little guys?

Make no mistake, DeFi projects are just an extension of the current financial system. They're just being re-branded and re-packaged. Gas fees be damned...

Your alarm bell,

OGF

P.S. - Please do your own research and due diligence before entering into any financial transactions. As stated earlier this is NOT investing advice. Thees are simply some of the experiences and stories I've heard about the DeFi world and I'm here to share them.

Part II of this guide will talk about providing liquidity on exchanges, what it is, and what to expect.