DeFi tokens represent a diverse set of cryptocurrencies native to automated, decentralized platforms that operate using smart contracts. These provide users’ access to a suite of financial applications and services built on the blockchain, into which $75 billion worth of crypto has been locked.

Decentralized finance (DeFi) tokens command a $114 billion market cap, a relatively small proportion of the overall $1.7 trillion cryptocurrency market. That being said, it has become one of the fastest-growing sectors in the industry, up from $89 billion the previous year.

Decentralized finance is an interconnected ecosystem of non-custodial financial protocols, platforms and services.

LUNA is the largest DeFi token, with a market cap of $34.3 billion. It’s the native currency of the Terra network, where it’s used to collateralize mechanisms that back Terra’s algorithmic stablecoins, such as U.S. dollar-pegged TerraUSD (UST). Terra is also used in the network’s proof-of-stake consensus mechanism, where validators stake the tokens and are rewarded for providing security to the network.

DAI, a USD-pegged stablecoin minted by MarkerDAO, is the second-largest DeFi token by market cap, according to Coin Gecko’s list of DeFi tokens.

It’s followed by Chainlink's LINK, the native token of the decentralized oracle network that feeds smart contracts with accurate, real-world data such as weather reports or price information.

In third place is lido staked ether (SETH), which represents Ethereum that has been staked within staking protocol Lido.

Although cryptocurrency market trackers like CoinMarketCap and CoinGecko group all DeFi-related projects under the same category, they can be further differentiated based on the governance tokens some DeFi protocols offer.

Most DeFi tokens are linked to DeFi protocols, which, in some instances, are governed almost entirely by their community of users.

To participate in the future decision-making processes of these types of DeFi platforms, users are required to purchase and hold what’s known as “governance tokens.” These tokens possess special rights and allow holders to vote on proposed changes to the platform. These votes are nominally binding on the developer team and their values are often proxies for confidence in the project.

Decentralized exchange Uniswap’s native token UNI is the largest governance token of its kind, with a $5.9 billion market cap. Uniswap launched UNI in September 2020, airdropping 400 UNI tokens to each wallet address that had interacted with the protocol at least once before September 1 of that year. That’s about $3,340 worth of free money, as of this writing.

As a general rule, users who hold more of a particular governance token have greater voting powers over those with fewer tokens. This is done under the assumption that those who are willing to invest more in a particular project are more likely to want it to succeed, and will therefore vote on the most appropriate proposals to achieve that goal.

Since Uniswap’s airdrop, many other protocols have also airdropped governance tokens to early adopters to encourage participation in the voting process. Governance tokens can also be earned through active contribution to the protocols, for example by providing liquidity to a protocol’s asset pools.

Other major governance tokens include:

PancakeSwap (CAKE)Aave (AAVE)Maker (MKR)

Governance tokens are also speculative assets, just like most other cryptocurrencies. You can trade them on centralized or decentralized exchanges without partaking in any governance decisions, and their prices typically fluctuate like any other volatile asset.

Some newly issued governance tokens may be non-tradable until the token holders decide they can be transferred between wallets.

DeFi tokens might sound like tokens you can only buy on DeFi protocols, but that’s not the case at all. Most centralized cryptocurrency exchanges like Coinbase (COIN), Binance and FTX list major DeFi tokens. These can be traded or invested in just asd you would any other type of cryptocurrency.

In order to participate in protocol governance, you will need to hold the tokens in a DeFi wallet and connect the wallet to the governance platform used by that particular protocol, such as Snapshot. It’s worth noting, participation in governance does not incur any gas fees.

Read more: What Are Ethereum Gas Fees?

Even if you buy DeFi tokens through platforms that aren’t DeFi-based, such as centralized exchanges like Coinbase, you’ll still be exposed to DeFi risks associated with the protocols those tokens represent.

DeFi tokens may suffer significant losses when the underlying protocol suffers a critical vulnerability. In October 2021, the price of COMP, lending protocol Compound’s governance token, plunged when millions of dollars were drained from its treasury after a fault in the code was exploited by a hacker.

Read more: The Big 5 Risk Vectors of DeFi

Like other cryptocurrencies, changes in the project or the team may also shift market sentiments. In March 2022, DeFi tokens associated with Andre Cronje’s project fell sharply when he and a colleague announced their departure from the industry.

If you want to invest in DeFi and but you’re not sure in which token to invest, you might want to consider a DeFi token index fund, such as The DeFi Pulse Index (DPI) offered by Index Coop. The token tracks the performance of DeFi tokens in its basket, such as UNI, AAVE and MKR.

However, remember that neither The DeFi Pulse Index (DPI) nor individual DeFi tokens will necessarily track the long-term success of DeFi – just as shares on the stock market can take a life on their own independent from a company’s success.

Moreover, the risks of investing in DeFi also apply to index funds. Indexed Finance, another index fund protocol, suffered a $16 million exploit in October 2021.

This article was originally published on Mar 14, 2022.