How DeFi works: Replacing traditional financial intermediaries with smart contracts
Key Takeaways
- DeFi offers financial services without traditional intermediaries
- Key DeFi applications include lending, trading, and yield farming
- New Zealand users can access DeFi platforms globally
- DeFi investments carry higher risks but potential for greater returns
- Understanding smart contracts is essential for DeFi participation
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What is DeFi? Understanding Decentralized Finance
Decentralized Finance, or DeFi, represents a revolutionary approach to financial services that eliminates traditional intermediaries like banks and financial institutions. Instead, DeFi relies on blockchain technology and smart contracts to provide financial services directly to users, offering greater accessibility, transparency, and potential returns.
Key DeFi Applications for Kiwi Investors
Lending & Borrowing
Earn interest by lending your crypto assets or borrow against your holdings without credit checks.
Popular Platforms:
- Aave
- Compound
- MakerDAO
Potential APY: 1-15%
Risk Level: Medium
Decentralized Exchanges
Trade cryptocurrencies directly from your wallet without intermediaries or KYC requirements.
Popular Platforms:
- Uniswap
- SushiSwap
- Curve Finance
Benefits: Privacy, token variety
Risk Level: Medium
Yield Farming
Maximize returns by providing liquidity to protocols and earning multiple token rewards.
Popular Platforms:
- Yearn Finance
- Convex Finance
- Beefy Finance
Potential APY: 5-100%+
Risk Level: High
Getting Started with DeFi in New Zealand
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1Set up a self-custody wallet
Start with MetaMask or a similar wallet that supports Ethereum and other DeFi-friendly blockchains.
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2Purchase ETH or other base currencies
Buy Ethereum or other supported cryptocurrencies from a centralized exchange that accepts NZD.
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3Transfer funds to your wallet
Move your crypto from the exchange to your self-custody wallet (be aware of network fees).
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4Connect to DeFi platforms
Visit DeFi websites and connect your wallet to interact with their smart contracts.
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5Start small and diversify
Begin with small amounts across different protocols to learn and manage risk.
DeFi Risks and Considerations for Kiwis
Important Risk Factors
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Smart Contract Risk
Vulnerabilities in code can lead to hacks and loss of funds.
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Impermanent Loss
Providing liquidity can result in losses if token prices change significantly.
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Regulatory Uncertainty
New Zealand's regulatory stance on DeFi is still evolving.
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Tax Implications
DeFi activities may create complex tax situations requiring professional advice.
DeFi Tax Considerations in New Zealand
The IRD treats cryptocurrency as property, and DeFi activities may trigger taxable events:
- Lending rewards are likely taxable as income
- Liquidity provision rewards may be taxable when received
- Token swaps could be considered disposals for tax purposes
- Yield farming rewards are typically taxable as income
Note: Always consult with a tax professional familiar with cryptocurrency taxation in New Zealand before engaging in significant DeFi activities.
Conclusion
DeFi represents a significant evolution in financial services, offering Kiwi investors unprecedented access to global financial opportunities without traditional gatekeepers. While the potential returns can be attractive, it's essential to approach DeFi with caution, thorough research, and a clear understanding of the risks involved.
Start small, diversify across protocols, and continuously educate yourself about this rapidly evolving space. With the right approach, DeFi can become a valuable component of your cryptocurrency investment strategy.
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Disclaimer: This article is for informational purposes only and does not constitute financial advice. DeFi investments carry significant risks including total loss of capital. Always do your own research before investing. I earn via affiliate links. Crypto's risky; not advice. NZ 18+