It might be helpful to begin by defining what a crypto wallet is. A cryptocurrency wallet is the digital storage locker for cryptocurrency, though many serve additional functions. Non-physical cryptocurrency requires a digital wallet, as well as private keys denoting who the owner of the wallet (and the cryptocurrency within) is. Crypto wallets serve both of these functions.

In order to establish an operational crypto wallet, a person may have to:

• Choose a wallet provider
• Input certain personal information
• Link a funding and deposit source, such as a bank account

Once a user takes these steps, they may be able to purchase and sell cryptocurrency, buy goods and services using crypto, and engage with decentralized finance (DeFi) products like decentralized exchanges and lending services.

Choosing a crypto wallet requires more consideration than you might think.

There are two broad categories of crypto wallets: hot wallets and cold wallets. Hot wallets refer to those that are (generally always) internet-connected. Cold wallets are not directly connected to the internet, but may become so in order to complete transactions. Let’s dive further into the specific types of crypto wallets.

Crypto Wallet Type #1: Paper Wallet

Services such as the Dash paper wallet generator allow users to print their:

• Private keys, or the encrypted signature that makes a wallet specific to an individual
• Random public address, which Coinbase likens to an email address, as it allows other users to know where to send cryptocurrency to

A paper wallet may also contain a scannable QR code for easier transactions, including but not limited to payments and crypto trades. 

Some of the benefits of a paper crypto wallet are:

• That a user can have physical possession of their public and private keys
• That a paper wallet is not immediately hackable
• That a paper wallet is disconnected to the internet, and is therefore not as vulnerable to energy- or internet-related problems as hot wallets are

Paper wallets may be as safe as the user that possesses them. While digital hacks may be averted with a paper wallet, it is vital that the owner of a paper wallet ensure its safekeeping, as losing it could have disastrous consequences.

Crypto Wallet Type #2: Desktop Wallet

Desktop wallets may generally rank behind paper wallets in terms of security (hacking-related security, at least), but ahead of online crypto wallet alternatives. 

The ostensible difference between an online-only crypto wallet and a desktop wallet is the act of downloading the wallet itself. This act results in a user’s private keys being stored on their computer hard drive rather than on an online server. In some cases, this information could be stored both on a desktop and an online server.

Having a wallet saved on one’s desktop could come in handy if:

• An online wallet host is hacked
• An online wallet host crashes

Crypto Wallet Type #3: Online Wallet

Online (or Web) crypto wallets may be the most immediately accessible and low-maintenance way to store and trade tokens. Casual crypto traders and investors may gravitate towards online wallets because:

• A third-party service may do all of the heavy lifting (providing the wallet, keys, and maintaining the server)
• An online wallet may have an easy-to-use interface
• An online wallet may be accessible from any device with an internet connection
• An online wallet may allow trading and crypto wallet services in one platform
  

Crypto Wallet Type #4: Hardware Wallet

Hardware wallets offer the physical, in-your-hand nature of paper wallets, but may offer additional features and significantly more pizzazz. Hardware wallets generally have common features including:

• A screen
• A handheld size
• Buttons or other means of operating the wallet
• The capacity to store a significant amounts and various types of cryptocurrency
• Computer connectability 

Ledger produces hardware wallets that have proven popular among crypto owners who want physical control over their token stores, as has Trezor.

Online wallets, put simply, may be the convenient option. History has shown that they are not the security-first option, however. Always connected to the internet, your online wallet could be the victim of hacking, and if the host becomes corrupted, then your wallet may be compromised just the same. You may also be taking a gamble that the hosts of the online wallet service are ethical.

Hardware wallets store users’ private keys. Unlike paper wallets, hardware wallets may have security features that prevent access to private keys in the case that the wallet falls into the wrong hands. 

One pull factor for hardware wallets is their offline nature. This, like paper wallets, makes them less vulnerable to hacks, third-party malfeasance, and other threats that loom over internet-dependent wallets. Yet, owners of hardware crypto wallets may connect their device to the internet at any time to conduct transactions. 

This gives hardware wallets a sort of hybrid nature that may prove appealing to security-conscious crypto traders.

Crypto Wallet Type #5: Mobile Wallet

Cell phones have become highly sophisticated and ever-present, and many buyers, sellers, and holders of cryptocurrency prefer mobile wallets. Many online wallets offer a mobile version, while some wallets are exclusively designed for mobile use.

Mobile wallets may warrant the same security-related concerns that any hot (internet-connected) wallet does. The funds in your mobile wallet may be only as secure as the host providing it. For that matter, it may be only as secure as your mobile device. Therefore, there is certainly an element of “buyer beware” to anyone who uses a mobile crypto wallet.

However, there are clear benefits of mobile wallets. They include:

• Extreme convenience
• Mobility
• All-in-one platforms that allow banking and trading
• Compatibility with both Android and iOS operating systems
• The ability to pay from a mobile wallet through QR-enabled scanning

In an increasingly mobile-dependent world, mobile crypto wallets offer clear benefits. You may weigh these pros and cons of different crypto wallet types when choosing the right wallet for yourself. Nomics provides a comprehensive rundown of cryptocurrency wallets in their many forms.

Yield farming is a way for those who participate in specific cryptocurrency-powered products to use their crypto to earn crypto. By promising users tokens (and interest, in some cases) in exchange for their participation, founders and promoters of decentralized finance products aim to whip up interest in their platforms.

What Is Yield Farming?

Understanding yield farming may require you to grasp what “yield” means within the context of finance. Per Investopedia, yields are “earnings generated and realized on an investment over a particular period of time”. Yields may generally come in two specific forms:

• Interest earned on an investment
• Guaranteed dividends paid in return for your investment

Yields can apply to several classes of financial assets, including but not limited to stocks and bonds. Yields can be fixed or may fluctuate with different variables, such as the value of the security being invested in. These same tenets may apply to yields issued in cryptocurrency rather than dollars, but there are also some noteworthy differences between traditional yields and crypto yields.Yield farming is a term particular to cryptocurrency, and DeFi specifically. Simply put, to farm yields is to invest your cryptocurrency in a specific DeFi platform or product in exchange for rewards, which may come as interest and/or dividends. 

Some of the most prominent projects to date for yield farming, such as Compound, involve both lenders and borrowers of cryptocurrency receiving Compound tokens (COMP) as their yield. This practice may also be referred to as liquidity mining, because those who invest their crypto in platforms while earning a yield are providing liquidity to administrators of that platform. In this sense, their role is similar to a lender who exchanges cash for:

• The guarantee of future repayment, plus:
• Interest payments

While the investor farming a yield certainly benefits from the arrangement, they may not be the only ones reaping a reward.

Who Benefits From Yield Farming?

It is clear why someone might invest their cryptocurrency in a platform or product that offers them a yield. If they were not planning to liquidate their crypto shares in the near-term, then why not earn some extra (guaranteed) coin on their stake by farming for yields? Here’s how it goes:

An investor lends their money to the platform, they receive tokens for their investment, they are ultimately repaid their principle investment, and may earn interest on top of it. It’s the classic lender’s benefit, along with some extra token. That extra token is a key distinction between traditional lending and yield farming with DeFi platforms. If the value of the token provided as a dividend skyrockets, then a DeFi lender-investor may experience returns far beyond what they could get in traditional, non-crypto markets.

Heck, if the token being used as a dividend accumulates value quickly enough, it may even be possible to make money farming yields as a borrower. Say someone borrows cryptocurrency and receives tokens as a reward for engaging in the lending platform. So long as the value of that token increases at a rate greater than the cost of borrowing, they may ultimately earn a profitable yield despite paying interest on their loan. There is always risk in borrowing, and one would have to be very confident in the rate of a token’s appreciation to bank on making money by borrowing crypto. Still, this scenario is not out of the realm of possibility, and the rapid increase in value of Compound’s COMP token just months ago serves as real-world evidence.

The last party that may benefit from yield farming is the governors of a specific platform or token. Whether governors refers to a centralized collective or participant-investors in a decentralized platform, the interaction that yield farming incentivizes is generally positive for stakeholders.. As investors flock to a platform offering worthwhile yields, the platform itself and any connected token becomes more valuable due to greater popularity. As the token accumulates value, the yields (tokens) provided by participation in the linked platform become more attractive, more farmers flock to reap those yields, and so the cycle of growth goes…

What Is the Current State of Yield Farming?

Like many specific genres of decentralized finance, yield farming has seen significant growth in participation over recent years, and in the past few months especially. With Compound paving the most viable blueprint for yield farming to date, subsequent projects have garnered similar popularity. Balancer Labs’ BAL token was issued shortly after COMP token’s debut, becoming the second governance token that would facilitate yield farming in the DeFi space, according to NASDAQ. It went on to debut with a single-day 235% spike in value, once again illustrating the fervor for yield farming, and by extension the tokens and platforms that allow for yield farming.

As more and more investors sink their crypto capital into platforms offering yields in return for liquidity, the sustainability of the practice appears real. Unless regulators crash the party, the attractiveness of yield farming may persist. 

How Do Regulators View Yield Farming?

You’d have to be a regulator to answer this question. Generally speaking, there is some worry that regulators will eventually want to have a say in how the DeFi sector is run, including how punitive measures are doled out to fraudsters. Yield farming may not be immune to this development if and when it occurs. Whenever the term “risk” becomes associated, fairly or not, with a financial sector, you can bet that at some point regulators will act. Whatever you think of their motives, this generally tends to be the case.

Like any investment, yield farming carries risk, with questions about the token issuers’ legitimacy being one of those risks. However, it is not yet possible to know for certain how regulation will affect yield farming. For now, yield farmers seem to be of the opinion that they may as well be getting it (yields) while the getting is good.

That’s part of it, but there’s more to the story.

So what is decentralized lending, how does it differ from traditional lending, and what is the outlook for this relatively nascent category of financial products?

What Is Decentralized Lending?

The mechanisms of decentralized lending are fundamentally very similar to traditional lending:

• One person lends assets, doing so in exchange for interest payments (and in some cases, additional rewards)
• Another person borrows assets, paying interest payments for the right to instant funding 

Rather than dollars, however, decentralized lending relies on cryptocurrency as the medium of exchange. Various platforms exist by which users can engage in lending-related transactions (more on that later).

Smart contracts are the mechanisms which facilitate decentralized lending. These contracts are self-executing protocols which may have several functions (distributing interest payments, enacting variable interest rates, and implementing other terms of a loan, for example). 

These contracts are unbiased, incapable on their own of nefarious motives or bad faith tactics, and allow all participants in a lending transaction to see precisely where they stand at any given time. In other words, they’re not banks.

What Are the Perks of Decentralized Lending?

Investment in decentralized lending platforms has absolutely skyrocketed in 2020, but why?

Widespread mistrust of traditional financial institutions may play a large part in bullishness towards DeFi lending. CNBC explains how millennials in particular have shown a wariness towards traditional banks, citing The Great Recession among the reasons for skepticism. 

With banks required to keep 0% of customer deposits on hand, per the Fed, it seems that willingness to try non-traditional financial products is rampant. Consider the proposed benefits of decentralized lending:

• Rather than having a financial institution with a spotty track record involved in your financial transaction, DeFi lending allows a smart contract to execute the transaction
• For lenders, interest rates on certain DeFi lending platforms may far outpace returns for other centralized investment alternatives
• Rather than a large, faceless bank reaping the rewards of lending, DeFi lending offers a peer-to-peer experience
• Lower barriers to securing a loan than are present in traditional lending processes (if you have the necessary crypto collateral, you may generally be able to secure the loan you seek)

From an investor standpoint, borrowing cryptocurrency may prevent having to sell existing stakes in crypto, which may come with fees and opportunity cost. Based on the massive infusion of capital in DeFi lending platforms in the past few months alone, it is clear that the perks of decentralized lending have legitimate appeal.

What Is the Current State of Decentralized Lending?

DeFi Pulse’s DeFi List shines a light on 12 separate decentralized lending platforms. The amount of digital assets tied up in decentralized lending platforms is substantial, with leading platforms Compound, Maker, and Aave collectively accounting for significantly more than $3 billion in digital assets on their own. DeFi Pulse keeps a running account of the entire DeFi lending industry’s “locked” assets. 

$3 billion and change is noteworthy, and becomes even more eye-catching when considering that DeFi lending markets have seen a massive infusion of capital in 2020. Still, decentralized products for lending and borrowing appear modest when compared with traditional lending. Outstanding consumer debt issued through centralized sources is more than $13 trillion.

The sizable asset gulf between DeFi lending platforms and traditional lending institutions is informative, but says little about the long-term viability of DeFi lending. The headstart that established financial institutions have on decentralized alternatives (2016 spawned the earliest DeFi lending platforms) must be considered when making comparisons.

DeFi lending platforms must be evaluated on their own merits, rather than in comparison to centralized alternatives. Through this lens, decentralized lending is a product that investors are very bullish on.

Some have observed DeFi lending’s transition from “niche” to “mainstream” (injecting billions in capital in a matter of months will have that effect). The de facto marriage between the Ethereum blockchain and DeFi lending products serves as something of a blueprint, and at this point DeFi lending is well established as a force in the projected financial markets of the near and distant future.

How Do Regulators View Decentralized Lending?

If there is one potential threat to DeFi lending, it is the same concern that clouds the crypto sector more broadly: regulation. 

Publications such as Reuters have thrown around terms like “freewheeling” to describe the state of crypto lending. These sorts of terms, generally speaking, are the sort that tend to catch the eye of regulators. 

With its massive and growing popularity to the tune of billions of dollars invested, there is no doubt that conversations about DeFi lending have already been had in the offices of the Securities and Exchange Commission (SEC). But one unanswered question remains: how, exactly, will the SEC treat DeFi lending platforms?

There is some fear that these platforms will receive treatment similar to that of Initial Coin Offerings (ICOs). In 2018, ICOs became tied to unsavory phrases like “securities fraud” and “conspiracy” when the SEC took legal action against multiple crypto firms. CNBC’s take on the SEC’s message: “new digital financial products must follow traditional securities rules”.

If this proves to be the case with DeFi lending platforms, then there may come a time when regulators begin to enforce the “traditional securities rules” to which decentralized lending products may or may not be subject.

1. Decentralization, which is provided by blockchain technology
2. Non-custodial products, meaning that there is no middleman between the user and the financial product being utilized, only a protocol

With these founding principles laid out, what is decentralized finance? What are its benefits and drawbacks, and how is it being viewed through the all-seeing eyes of regulators?

What, Exactly, Is Decentralized Finance?

Breaking down the term “decentralized finance” may be a simple, yet effective starting point for explaining the emerging phenomenon. 

Let’s start with finance.

According to Investopedia, the noun finance refers to “matters regarding the management, creation, and study of money and investments”. For the sake of the DeFi discussion, the management and creation of money and investments may be the most pertinent features of this definition.

The Corporate Finance Institute (CFI) provides specific examples of finance, including “investing, borrowing, lending, budgeting, saving, and forecasting”. Lending, investing, forecasting, and borrowing may generally be the most relevant of these examples when it comes to decentralized finance.

And what about the “decentralized” aspect of DeFi?

Merriam-Webster provides two definitions of “decentralization”:

• the delegation of power from a central authority to regional and local authorities
• the dispersion or distribution of functions and powers

Each of these definitions apply to decentralized finance. Collectively, decentralized finance appears to be the engagement in finance-related activities such as lending, borrowing, investing, and forecasting through means that have no central authority, where instead management over a financial system (insofar as there is management) is dispersed.

From a 1,000-foot view, this is an accurate depiction of the core tenets of DeFi. Now to get a bit more specific…

Decentralized finance comprises financial platforms and services built upon and powered by blockchain technology. These services vary in their purpose and specifics, but may generally allow users to borrow or lend cryptocurrency, purchase and sell coins, speculate on the future value of commodities, and purchase or sell tokenized assets.

Like other evolutions in the finance sector over the years, decentralized finance is a new way of engaging in the economic activities that facilitate the making (or losing, if you’re unlucky) of money. The primary pull factor is that, rather than requiring a middle man/institution, it is the users who control the mechanisms that facilitate their transactions (at least in theory).

What Allows DeFi to Work?

In short, blockchain technology and specific protocols allow decentralized finance to function. Beneath both of these critical elements is the internet, without which blockchain technology would not be possible.

One definition of a protocol is a “set of rules or procedures that govern the transfer of data between two or more electronic devices”. When protocols exist on a blockchain, a network of computers, known as nodes, carry out specific protocols. These protocols govern features of a blockchain such as:

• The algorithmic mechanisms by which nodes communicate
• The means of approving transactions within the blockchain
• The means by which new nodes are accepted into the blockchain

These protocols undergird blockchains in general, and are therefore the enablers of decentralized financial products. The specific ends to which DeFi application founders use these protocols determines what each product can do for its users.

What Are the Benefits of Decentralized Finance?

The benefits of decentralized finance vary from one general DeFi category to the next, and even one application to another.

But, generally speaking, the benefits of decentralized finance lie primarily in decentralization as a principle. Without decentralization, the benefits of DeFi become far less obvious.

The thinking goes that centralized financial institutions are flawed in several ways, including but not limited to:

• Lack of control over how the system works by those who prop the system up (the financial consumer)
• Lack of transparency into how decisions affecting the financial system are made
• Lack of control over and transparency into how your specific deposits are handled
• The potential that arbitrary or bad-faith decisions by financial institutions or regulatory bodies could put your deposits at risk

Proponents of DeFi aim to flip these flaws on their heads. Their goal: to use the antithesis of centralized financial institutions—decentralized financial products—as the selling point for their DeFi products.

In an ideal decentralized financial system, benefits would include:

• Democratic control by participants (financial consumers) over how a system works 
• No central authority with outsize power to affect the fate of participants’ deposits
• Greater reach to customers regardless of geographic location, as all one would theoretically need to participate is an internet-connected mobile device
• Less vulnerability to outside breaches due to decentralized security protocols
• Greater autonomy to customize specific blockchain protocols democratically, which may allow dynamic shifting of interest rates for lending cryptocurrency as one possible benefit

Trustworthiness is a key benefit of DeFi, as agreements are solidified by smart contracts which manage the exchange of coins. Rather than simply having faith that a bank will come up with your assets (which they’ve lent out in the meantime) when you request them, smart contracts provide guarantees that your coins will be delivered when predefined conditions are met.

Keep in mind that these are ideals of decentralized finance, and time will tell the extent to which real-world DeFi products live up to these gold standards.

What’s the State of DeFi Today?

As of now, decentralized finance is virtually synonymous with the Ethereum (ETH) blockchain, known for its customizability and user-friendly interface. DeFi Pulse notes how existing, Ethereum-based products in the DeFi space offer:

• Lending and borrowing of cryptocurrency
• Decentralized exchanges for purchasing cryptocurrency
• The ability to bet on fluctuations in the value of assets by purchasing synthetic derivatives
• Peer-to-peer payment services 
• Tokenized asset management

You can view an extensive list of DeFi products, including industry lending leaders such as Aave, Maker, and Compound here. 

It is fair to state that decentralized finance mirrors the slate of non-decentralized financial products, sans the middle man (traditional financial institutions). Another difference between DeFi and more traditional financial products is the relative youth of the decentralized finance sector, which continues to evolve at a rapid clip.

How Do Regulators View DeFi?

There seems to be a looming spectre that regulators will come for DeFi products, sooner or later. Just as the Security and Exchange Commission (SEC) eventually cracked down on ICOs in the name of curbing digital fraud, some have gone so far as to state that “regulators are circling” the DeFi sector.

As with any regulatory matter, speculation and opacity will rule until regulators—the SEC or otherwise—make an overt move. Calls for self-regulation as a means of warding off outside regulation may, if history is any indicator, range from naive to overly optimistic.

The perception that those who create DeFi products are not spawning truly decentralized products, but are rather in it for their own personal gain, is surely not helping the case of those who hope to rebuff outside regulation.