You may have heard about the concepts of Ethereum and DeFi from colleagues, family or friends, and then want to know more. It's no wonder people are talking about DeFi (decentralized finance), which is a fast-growing financial sector. Currently, DeFi applications on Ethereum control $500 million worth of digital assets, and even more surprisingly, the annual interest earned by users from the DeFi lending platform has remained between 5% and 20%.
There are too many knowledge points involved, and it is difficult to determine where to start. Therefore, we have compiled this guide to help you step into an exciting new world of decentralized finance. After mastering this guide, you will see that the money you invest in grows every few seconds and you earn more interest per year than any bank. So let's start learning. (Reminder: the cryptocurrency "old driver" can skip the first part directly)
First, 10 concepts that must be mastered before playing Compound and DeFi
Before you start, you need to understand the following concepts (introduction):
- Why is the project of Stanford University becoming more and more in China?
- Coinbase announces the transition to global Staking service, Staking becomes the most critical investment strategy in the blockchain ecosystem
- Viewpoint | The cryptocurrency industry has reached a watershed, IXO to the left, mature public chain to the right
- Is it time for the exchange to access the lightning network transaction?
- Jia Nan Technology Zhang Nan’s two or three things
- Head of FinCEN, USA: Anyone must abide by the Anti-Money Laundering Act (AML), and the stable currency is no exception.
1. What is cryptocurrency?
Cryptographic currency is a new type of digital asset that is created, maintained, and protected by a dispersed network of participants. A distributed ledger called a blockchain that is used to securely store and distribute cryptocurrencies.
2. What is a cryptocurrency wallet?
Cryptographic wallets are typically software applications (also hardware) that are used to send and store cryptocurrencies, and users can use wallets to interact with decentralized apps. A wallet can be roughly compared to a bank account, except that the asset custodian is himself, not the bank.
There is no complicated process for wallet registration. It is usually composed of 12 or 24 word phrases. These words are called seed words (or mnemonics). You can master these phrases and you can recover your wallet from anywhere.
3. Why is my seed phrase (mnemonic) important?
As mentioned earlier, seed phrases can be used to recover your wallet. If you lose them, this means you can no longer import your wallet from elsewhere, and your funds may be lost forever. This is why backing up your seed phrases is so important.
4. How can I protect my cryptocurrency from being stolen?
In general, to protect yourself from hackers or thieves, you need to follow best practices in cybersecurity and privacy. For example, keep your computer away from viruses or malware, use a secure password (or even a password manager), properly protect your network, and enable 2 verifications (such as google authenticator) whenever possible.
Here are some resources to help you learn the best security practices for online and offline.
- EFF's security foundation
- EFF safety course
- Mozilla data detoxification
- CryptoPaper : A Comprehensive Guide to Security and Privacy
5. What is Ethereum? What is Ethereum?
Ethereum is the world's leading programmable blockchain, while Ethereum is the native cryptocurrency on the Ethereum network. All transactions on the Ethereum network require Ethereum to pay for the transaction costs.
6. What is a smart contract? What is token?
Smart contracts make Ethereum a programmable currency. Smart contracts are applications or scripts that run on the Ethereum network. They can create and manage digital assets, and you can build complex and irreversible protocols without the need for intermediaries.
The digital assets created by smart contracts are called tokens. Tokens can represent multiple types of digital assets, such as currency, physical assets (such as gold), ownership shares in DApp, and more.
7. What is DeFi?
Decentralized Finance, referred to as DeFi, the Ethereum community called financial intelligence contracts, decentralized applications, and agreements established on Ethereum as DeFi. Popular DeFi products include decentralized exchanges, lending markets, tokenized physical assets (such as gold), derivatives, forecast/"spinach" markets, payment networks, insurance, and more.
8. What is the Decentralized Exchange (DEX)?
Decentralized exchanges, or DEX for short, are like stock exchanges operated by smart contracts on the Ethereum blockchain. Although both allow you to trade assets, decentralized exchanges only trade cryptocurrencies, so no central point is required to operate.
Using a DEX transaction can reduce some of the risk because you are putting the coin in your wallet, not on a wallet that is controlled by someone else.
9. What is DAI and MakerDAO?
MakerDAO is a smart contract that allows users to create a debt-backed position (CDP). The user deposits eth as a collateral and can generate or borrow a token called DAI, which is a stable currency anchored to the dollar.
The borrower pays an interest rate called a stabilization fee each year to give the opportunity to create a new DAI. When the debt is paid off, the stability fee owed by DAI and Maker's token MKR is burned together. The existence of a stabilization fee prevented the excessive expansion of the total supply of DAI.
CDP holders must have at least 150% outstanding debt collateral, and for each DAI, at least $1.50 worth of Ethereum is locked into the Maker CDP as collateral. If the value of the collateral declines, the CDP holder must lock in more eth, repay part of the debt, or face the risk of the position being liquidated. When the CDP is liquidated, the ETH as collateral will be automatically sold to repay the debt, and a penalty of less than 150% will be paid.
10. What is Compound? What is cDAI? Why can I earn interest?
Compound is a smart contract that allows users to borrow tokens. It's similar to your bank, and Compound lends your money to borrowers and earns interest over time. But unlike a bank, your interest is calculated from the compounding of your smart contract after you deposit it into Compound. Because this is a smart contract, it has no middlemen, so its interest will be higher than the traditional bank.
Similar to MakerDAO, Compound's loan was established through an over-guarantee. The borrower deposits the token into the Compound to increase their “borrowing ability”. If the borrower's borrowing ability is below 0, their collateral will be sold to repay the debt. In addition, the loan interest rate for each asset is different, depending on the needs of the asset.
Second, risk tips
Is it safe to participate in DeFi? Of course there is no such good thing, please see the Risks and Notes section below:
- You may forget your seed phrases (mnemonics) or not properly back them up. This is equivalent to losing your access to the wallet, which means you can't recover the funds locked in your wallet. This is why it is so important to keep them safely.
- Whether in physical or digital form, your seed phrases (mnemonics) can be stolen. As mentioned earlier, if someone can access your seed phrase, they can steal your money. Don't enter your seed phrase on the website. In addition, attacks such as phishing emails are a common way for hackers to steal user funds.
- There may be security vulnerabilities affecting DAI in Maker, and Maker has performed several third-party audits of its code to remove vulnerabilities. These precautions are very important to minimize the risk in the system. Despite this, there may still be potential risks. The Maker team lists comprehensive risks and mitigations in its white paper. Here is a three-part blog series that outlines their governance risk framework. The following is an example of a known but currently unresolved risk: Maker uses a set of out-of-chain price feeds to determine the price of eth on the chain. MakerDAO's medianizer smart contract finds the middle price between all price feeds, and then they are used almost every function of CDP. These price feeds may be manipulated by an attacker, or the medianizer smart contract itself may be affected by an error or an undiscovered vulnerability. So far, no such attacks or errors have occurred.
- There may be defects, errors or vulnerabilities in the compound that affect cDAI. The compound code has been audited many times, and OpenZepplin did not find a serious vulnerability in the latest audit conducted in August 2019 (but also found some system risks). Previously, Trail of BITS audited the code for the Compound v2 version in May 2019. In addition, Compound also worked with Certora to verify its contract code. In addition, Compound Labs, the developer of the Compound protocol, currently controls the management address of the Compound. The administrator address has the right to support additional assets, upgrade price feeds oracle, upgrade interest rate models, and risk models for upgrade agreements. Unknown vulnerabilities may be introduced when they plan to fully decentralize this and hand over control to the community. It should be noted that such vulnerabilities or attacks have not occurred so far.
- Life is unpredictable, which means you need to make the worst plans (such as encounters). If this happens, think about how your family can receive your money. There is no perfect solution to this problem. So, you have to come up with a plan that works best for you.
- Understanding legal and tax obligations: We will not give you legal or tax advice, however, you should be aware that having a cryptocurrency and having any financial asset will have a tax effect. And, almost certainly, you will owe taxes because you earn interest on defi. Please consult a tax professional in your area for more information.
Ok, after reading the above information, we enter the official theme:
Third, how to earn passive income through Compound
1. Create an exchange account (eg Coinbase) – "Verify Identity (KYC) – "Enable 2-Step Verification -" bind the bank account to the exchange account;
2. Install and create your own Ethereum wallet, such as MetaMask
Metamask is a web plugin wallet that allows you to interact with the Ethereum blockchain and manage the Ethereum wallet private key in the browser.
Go to metamask.io and click the orange "Get Extension" button. After the installation is complete, you should see an orange little fox icon on the right side of the browser's address bar. Click on the fox icon and click the "Continue" button and set your own wallet.
The next step is to set the wallet access password and then securely record the seed phrase (mnemonic) generated by the wallet. Press the "Confirm" button when done.
Congratulations, you have created an Ethereum wallet.
3. Use French currency to buy Ethereum
In this tutorial, because you are using Coinbase, you can deposit USD or Euro directly into your Coinbase account via bank or wire transfer (if it is another exchange, you buy the stable currency through OTC, and then buy the Ethereum through the exchange. ).
It is worth noting that cryptocurrencies such as Ethereum are highly volatile, so don't invest more than you can afford.
4. Bring the Ethereum you bought on the exchange to your own Ethereum wallet (eg MetaMask)
Let's mention the purchased ETH in our MetaMask wallet, find the "ETH" option in the exchange's account balance, click the Withdraw button, and enter the destination and amount of the withdrawal ( please check carefully. Since the transaction is irreversible , click OK when you are sure, and the system will prompt you to enter the 6 digits in the 2FA application. After completing and waiting for a while, your funds on the exchange will be transferred to your Metamask wallet.
5. Convert Ethereum to DAI via Decentralized Exchange (DEX)
Open DEX.AG, a DEX aggregator that aggregates 11 different DEXs to find the best price for your deal.
By default, DEX.AG will be set to purchase DAI using Ethereum. Next, enter the amount you want to exchange. You can check your own Ethereum balance in MetaMask.
Note: Do not enter all funds, you need to keep some eth to pay for the online transaction costs called gas. Depending on the type of transaction you send and the current network, the average transaction will cost between $0.10 and a few dollars. (Thus, you must keep at least a few dollars worth of ETH for transaction fees. For reference, at the time of this writing, eth's market price is about $200, so you need to keep 0.01-0.1 eth)
After entering the amount (minus the ETH reserved for gas), click the "Find Transaction" button. You should see an index list on the screen. Then, click on the "Sell Now" button on the dex closest to the top, and a MetaMask prompt will appear immediately. Since this is the first time your account has interacted with this dex smart contract, you have to send two transactions: one is to approve the transaction, then one is a formal transaction. The first time you interact with a smart contract, you must submit an approval transaction that will allow the smart contract to transfer your tokens (such as DAI) when necessary.
You can manually adjust the gas fee before sending the transaction, which may save you time (increasing the cost) or save your transaction costs.
After a while, the transaction will be confirmed. To track the confirmation status of a transaction, you can open the MetaMask menu, click on the transaction to be confirmed, and then track the query through the Etherscan blockchain browser.
Once confirmed, click on the dex "sales now" button again, which will launch your transaction. Repeat the above steps to confirm and send your transaction. Once the transaction is complete, the corresponding DAI will be transferred to your wallet.
6. Convert DAI to cDAI through Compound Finance
Before choosing a lending service, I suggest you compare the interest rates. But for the sake of simplicity, we will teach you to use the now popular DeFi loan service, Compound Finance.
Enable DAI on Compound: Navigate to the Compound app . If no prompt appears, select the button in the upper right corner of the page to connect to your MetaMask wallet. Select Metamask and unlock your wallet. Next, select DAI from the menu and click the green "Enable DAI" button. This will pop up an approval transaction and you will confirm it using the same steps as before. To track the confirmation status of a transaction, open the MetaMask menu, click on the transaction to be confirmed, and then click the diagonal arrow on the right.
Once your approval transaction is confirmed, you should see two buttons: a green "supply" button and a purple "borrow" button. Click the "Supply" button and enter the number of DAIs to be supplied/lent (or select "Maximum"). After entering the amount, click on the "Supply" button at the bottom of the pop-up menu, which triggers a MetaMask transaction. Confirm the details of this transaction as before, click "Confirm", and wait for the transaction to be confirmed.
Congratulations, now that your cDAI is in your MetaMask wallet, you will get a passive income every 12 seconds. You can check the current interest rate of DeFi Pulse or Compound at Dai Supply APR and welcome to the future of finance.
Fourth, the conclusion
Any investment in the world is accompanied by varying degrees of risk. The same is true for DeFi. You need to take appropriate precautions to mitigate the risk, such as never investing more than you can afford.
Most importantly, congratulations on joining the digital economy of the future. In the world of defi, new products and services emerge every day, and innovation is happening at an alarming rate. Now you have become part of this special historical moment.
What can I explore next?
The following resources are available for you to explore:
- The DeFi List : A list of popular defi projects, products, services and media
- DeFi Pulse Income : Use this interest rate comparison tool to get the best lending rate in defi;
- Coinbase Earn : Learn and earn Ethereum tokens;
- EthHub : Community Ethereum Learning Information Center;