The Best Way To Offset Risk In The DeFi Space
When it comes to DeFi, the basic rules apply that are also equally applicable to Crypto in general. The only difference is that they are actually way more important in the world of DeFi. When well executed, they separate the successful players from the casualties. A lot of people avoid DeFi due to the perceived risks involved but the truth be known, funds are equally at risk simply lying on exchanges! The only difference is that once locked up in a DeFi protocol, funds begin to produce income.
A great Entry point is the most important aspect to succeeding and reaching ROI in the shortest amount of time. The reason that this is so important is not as simple as many may think. When one lends out Crypto assets or deposits capital into DeFi protocols, the first and foremost objective is always the same, which is to recoup your initial investment in the shortest amount of time.
Let me use CAKE, the PancakeSwap DEX token as an example. On average, locking up your CAKE in a DeFi pool or vault will earn you approximately 10% profit on your initial deposit per month. It is often more closer to 9% but we will use 10% for the sake of simplicity. An investor who purchases 10 CAKE at $28 has invested $280 and is earning $28 per month. If the price of CAKE drops, the investor will now be earning less, both in dollar terms and percentage terms of their initial investment. A drop to $14 would now see the investor only yielding 5% of their initial investment per month and only $14 per month.
Another investor sees CAKE start to take off earlier this year and decides to buy at the $7 mark. He proceeds to deposit his CAKE into a DeFi protocol when CAKE hits $28, which it now has. This investor also bought 10 CAKE but only payed $70 for his tokens, compared to the $280 of the previous investor. This investor also earns 10%, which equates to 1 CAKE, valued at $28. In one month he earns $28 on a $70 investment and recoups his initial investment within two and a half months, compared to the previous investor who will require 10 months. This excludes compounding but rather sees the investor withdraw profits on a monthly basis. It is all about your entry, which is why I will often buy beaten down DeFi projects that have significant TVL and a good reputation.
It is pointless buying a DeFi project while it is printing new all time highs because it will sell off when investors realize profits and sell the token.
Be Careful Of High Returns On LP's
I say this for one main reason and that is impermanent loss! I addressed this in a previous post, where I explain how you can effectively avoid impermanent loss. When utilizing LP's, equal amounts of each token have to be added to the contract. Once active, price fluctuations of the applicable tokens causes the algo to adjust holding allocations, in order to keep the pairings equal. This means that you can exit the contract at a loss. High returns are usually associated to volatile pairings, which could see your farming rewards being watered down by impermanent loss. Staking single tokens does not have this issue and exposes the investor to farming gains, while being exposed to price appreciation.
Choosing LP's should be done very carefully, as you want to maximize and accumulate as much gains as possible. In many cases, simply holding the tokens over time can yield greater gains due to impermanent loss that becomes realized loss.
Keep An Eye Out For Opportunities
Market corrections provide great opportunities for picking up DeFi tokens and one should definitely look at picking up the leaders in the space at discount prices. DeFi provides amazing opportunities and if executed correctly can become even more significant. These are my views and should not be considered investment advice.
