Is DeFi a Ponzi Scheme? 8 Important Facts

Decentralized finance (DeFi), particularly yield farming, has seen a dramatic surge in the last 18 months. Investors have made impressive returns on yield farming, prompting a rapid interest with everybody chasing the high yield dream. Unfortunately there are a lot of DeFi scams around, leaving many wondering whether DeFi is a Ponzi scheme. 

DeFi isn’t a Ponzi scheme, but there are qualities about it that make it similar. One of the most prevalent reasons is how its investors interact with the product. Due to its increase in popularity, DeFi investors have seen many scams, which have dampened its reputation.  

This article will cover eight things you need to know about DeFi when considering whether it’s a potential investment opportunity. 

Things To Consider When Investing in DeFi

With its attractive high yield potential, DeFi has begun to attract a swift increase of conventional investors. This sudden change in attitudes towards these products from those that usually favor traditional investments has increased since the impact that Covid-19 had on the financial world. 

With so much conflicting information on the latest crypto scams, it’s natural for investors to be worried about what DeFi really is. Here are six things you need to know about DeFi before investing in it.

1. DeFi Is Not a Ponzi Scheme

A Ponzi scheme is a fraudulent activity where existing investors are paid off with the money from new investors rather than the profits made from trading. It may seem similar to DeFi, but it’s not the same. The two are mutually exclusive because one requires trust while the other requires no faith at all. 

In addition to this, several features make DeFi different from a Ponzi scheme and instead make it more like a hedge or mutual fund. One of these features is that they’ve a fixed amount of tokens which means there’ll be no more investments once they run out of money. 

This makes it impossible for them to pay off new investors with old investor money as required in a Ponzi scheme, leading many experts to conclude that DeFi isn’t a Ponzi scheme.

If you’d like some more information on Ponzi schemes, check out this video from the Khan Academy. 

2. DeFi Is Not One Big Scam

According to Elliptic, the total loss caused by DeFi exploitation reached $12 billion by the end of 2021. There are a lot of DeFi scams out there. However, there’s also a lot of genuine money to be made.

To ensure you know which one is which, you should avoid investing in a project that guarantees high returns with little or no work. If it seems too good to be true, it usually is. 

Instead, look for DeFi projects that have been around for a while, have an established track record, and are completely transparent with how they make their profits. This will help ensure that your investment is secure, and if it isn’t, you’ll be able to find out before it’s too late to do anything about it.

3. DeFi Is Not Just for the Crypto Rich

One of the biggest myths concerning DeFi is that it’s only for crypto millionaires who want to invest in something more interesting than just sitting on their Bitcoins until the next bull run comes along. While this may be true in some cases, the fact is that there are plenty of DeFi startups that are completely free to use and can be used by anyone.

This includes several decentralized exchanges like BitMEX and P2P lending platforms like Compound. There are also some different lending platforms out there, and one offers borrowers the chance to earn interest on their cryptocurrency holdings while they sleep. 

Then there is MakerDAO, a platform for child chain token creation that allows users to issue their tokens without coding knowledge. This platform has been responsible for launching some of the most successful new cryptocurrencies in recent years, so it’s no surprise that it’s one of the most popular DeFi platforms.

4. DeFi Is More Than Cryptocurrency Investing

While cryptocurrency has been dominating headlines since Bitcoin first came onto the scene, this isn’t necessarily true for DeFi. While there are plenty of DeFi platforms designed to help cryptocurrency investors, several platforms allow users to borrow against their fiat holdings. 

This includes services like Salt Lending, which allows users to borrow against their crypto holdings, cash, and other assets.

5. Reduced Risk of Losing Assets With DeFi 

While it’s true that there is always some risk involved in investing in cryptocurrency, DeFi is different because the borrower never actually loses control over their assets. Instead, they pledge them to a smart contract that guarantees they’ll be returned once the loan has been repaid. 

So if anything happens to the borrower, they can still return their assets at any time without any problems. It also completely eliminates any concerns about defaulting on your loans and losing your assets with no way to get them back.

6. DeFi Can Earn Interest on Your Cryptocurrency 

One of the most significant benefits of DeFi is the ability to earn interest on your cryptocurrency holdings. This is particularly useful for investors holding their assets in cold storage, as they can’t make any interest on their holdings from a regular exchange.

Instead, they can use these assets as collateral for a loan and earn an attractive interest rate over time. If you want to learn more about how you can start earning interest on your crypto holdings, check out this video from 99Bitcoins.

7. DeFi Is More Liquid Than Stablecoins

One of the biggest criticisms of stablecoins is that their liquidity isn’t always very high compared to other cryptocurrencies. 

There aren’t many places where people can spend them, and they’re often limited to exchanges where users can trade them for other cryptocurrencies or fiat currencies. This makes it difficult for people to use stable coins to buy goods and services.

Decentralized finance is a more liquid alternative to stablecoins because various platforms allow users to trade their assets for other cryptocurrencies and fiat currencies. 

These platforms also allow users to earn interest on their holdings and borrow money against their assets. This makes them a much more versatile asset class than stablecoins, which can only be used to trade goods and services or exchange for other cryptocurrencies.

8. DeFi Is More Secure Than Stablecoins

DeFi is also more secure than stablecoins because it doesn’t rely on a centralized entity to hold your funds in escrow or act as an intermediary between you and your counterparty in the transaction. 

Instead, your crypto funds are held in a smart contract that you control directly, which means they aren’t vulnerable to third-party hacks or security breaches like the ones seen at Bitfinex and Mt Gox in the past.

Final Thoughts

Due to the increase in scams and hackers, the reputation of DeFi has been on a downward spiral, with some pointing the finger that DeFi is nothing more than a ponzi scheme. 

While there’s no denying that there are some catastrophic elements to DeFi, there are definite pros to the digital asset that outweigh the cons. These include: 

  • The accessibility for first time or small investors.
  • The ability for users to lend their digital assets adding dimension to the investment.
  • Reducing the risk of losing assets.
  • A better alternative to stablecoins.

Sources

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