DeFi Fundamentals

Published

December 9, 2024

Introduction

Decentralized Finance (DeFi) represents a fundamental reimagining of financial services. While traditional finance relies on banks, brokers, and other intermediaries, DeFi uses smart contracts – self-executing computer programs – to enable direct peer-to-peer financial activities. This shift removes gatekeepers and creates opportunities for anyone with an internet connection to access sophisticated financial services.

While Ethereum pioneered DeFi, its high transaction costs can make learning expensive, with fees sometimes exceeding $50 per transaction. This is why we’ll start our journey on Base, a Layer 2 network built on top of Ethereum. Base offers the same capabilities but with dramatically lower fees, typically under $1 per transaction. This makes it perfect for learning DeFi without fear of expensive mistakes.

Getting Your First ETH on Base

Now that you have Bitcoin in your Phantom wallet from following our earlier steps, we need to get some ETH on Base to begin exploring DeFi. We’ll use Coinbase for this process since they built Base and offer direct deposits.

Direct Purchase Method

The most straightforward approach is:

  1. On Coinbase Exchange:
    • Purchase $50-100 worth of ETH
    • Select “Withdraw”
    • Choose “Send to Base”
    • Send to your Phantom wallet’s Base address

This method is optimal because: - Coinbase handles the bridge transaction for you - You avoid paying Ethereum mainnet gas fees - The process is simpler than manual bridging - Base transaction fees are much lower

Understanding Base vs Ethereum

Base maintains a special relationship with Ethereum: - It inherits Ethereum’s security - Uses the same wallet addresses - Runs the same smart contracts - Costs much less to use

Think of Base like an express lane on a highway - it’s faster and cheaper while still getting you to the same destination safely.

Your First DeFi Steps

Before diving into trading and lending, let’s verify everything is working:

  1. Initial Setup Check
    • Confirm ETH appears in your Phantom wallet on Base
    • Ensure you’ve selected Base network
    • Have your Phantom wallet connected to Base
    • Keep transaction records for taxes
  2. Test Transaction
    • Send a tiny amount of ETH ($1 worth) between your own addresses
    • Notice how the gas fees are much lower than Ethereum
    • Get comfortable with Base network mechanics
    • Understand transaction confirmation times

Trading Fundamentals

When it comes to trading tokens on Base, using a DEX aggregator provides significant advantages over using any single decentralized exchange. Let’s understand why and how to trade effectively.

Understanding DEX Aggregators

DEX aggregators are like smart shopping assistants that find the best prices across multiple exchanges. We recommend ParaSwap for several reasons:

  1. Gas Efficiency
    • Optimizes routes to minimize gas costs
    • Particularly effective on Base’s already low-fee environment
    • Helps make small trades viable
  2. User Experience
    • Clean, intuitive interface
    • Clear transaction previews
    • Easy-to-understand settings
  3. Price Optimization
    • Splits orders across multiple DEXs when beneficial
    • Protects against price impact
    • Finds efficient trading paths

Your First Trade Using ParaSwap

Let’s walk through converting some ETH to USDC:

  1. Preparation
    • Visit ParaSwap’s official website (always verify the URL)
    • Connect your Phantom wallet
    • Verify you’re on Base network
    • Ensure sufficient ETH for both trade and gas
  2. Making the Trade
    • Select ETH as your “from” token
    • Choose USDC as your “to” token
    • Enter a small test amount ($10 worth)
    • Review the quoted price and gas fees
    • Understand the suggested route
    • Confirm the transaction

Understanding Slippage and Price Impact

When trading on Base, it’s crucial to understand how trade size affects price:

  1. Slippage
    • The difference between expected and executed price
    • Larger trades typically experience more slippage
    • ParaSwap helps minimize this through smart routing
  2. Price Impact
    • How your trade affects market price
    • Depends on available liquidity
    • Visible before trade execution

Understanding Gas on Base

While Base uses the same gas system as Ethereum, the costs are much lower:

  1. Typical Base Costs
    • Simple transfers: $0.01-0.05
    • Token swaps: $0.10-0.30
    • Complex DeFi operations: $0.20-0.50 Compare this to Ethereum’s fees which can be 50-100x higher!
  2. Gas Management
    • Keep $5-10 worth of ETH for gas
    • Monitor network conditions
    • Understand peak usage times
    • Plan non-urgent transactions

Lending Markets with Aave on Base

Now that you’re comfortable with basic transactions and trading, let’s explore lending markets. Aave is one of DeFi’s most battle-tested lending protocols and has deployed on Base.

How Aave Works

Think of Aave like a decentralized bank where you can both lend and borrow crypto assets:

  1. Lending Assets When you lend on Aave:
    • You receive aTokens representing your deposit
    • Interest accrues automatically in your wallet
    • You can withdraw anytime (subject to liquidity)
    • Your deposit can serve as collateral for borrowing
  2. Understanding Collateral and Borrowing Aave uses an overcollateralized lending model:
    • You must maintain a minimum health factor
    • Different assets have varying collateral factors
    • Monitor your position’s health regularly
    • Understand liquidation risks
  3. Safety First
    • Always maintain a health factor above 1.5
    • Set up notifications for position health
    • Keep some ETH for emergency transactions
    • Know how to repay loans quickly

Monitoring Your DeFi Activity

Stay informed about your DeFi positions:

  1. Essential Tools
    • DeFiLlama for protocol TVL and health
    • Base block explorer for transactions
    • Aave dashboard for loan positions
    • ParaSwap analytics for trading data
  2. Regular Checks
    • Monitor lending positions daily
    • Review transaction history weekly
    • Track portfolio performance
    • Stay updated on protocol changes

Remember: While Base’s low transaction costs make DeFi more accessible, never invest more than you can afford to lose. Start small, learn the mechanics, and scale up gradually as you gain confidence and understanding.