How to utilize AI agents in decentralized finance (DeFi) platforms

Key takeaways

• AI agents in DeFi are self-operating apps that can help navigate by optimizing trading, adding risk management and market analysis without human intervention.
• These agents integrate with DeFi platforms through smart contracts, offering automation for tasks like portfolio rebalancing, yield farming and enhanced security.
• AI trading agents adapt to real-time market conditions, identifying trends and executing trades 24/7 across multiple platforms.
• Despite their potential, AI agents face challenges such as reliance on high-quality data, regulatory uncertainties and vulnerability to security risks.

Imagine a world where trading is no longer limited to human financial knowledge and capacities. In this world, machines don’t just execute trades but also adapt and continuously optimize strategies on their own. This isn’t the distant future; it’s the reality emerging in decentralized finance (DeFi) today, thanks to AI agents.

AI agents are self-operating software programs that can make decisions independently, without human interaction. They use machine learning algorithms to refine their processes and adapt continuously. 

In traditional finance, AI has already transformed trading, risk management and customer service. In DeFi, where trust is built on code, not intermediaries, AI has opened new avenues for autonomy, transparency and effectiveness.

This article will explore what AI agents are and how to utilize AI in DeFi platforms.  

How AI agents power DeFi

AI agents are like helpful robots that live inside DeFi platforms and manage finances. They’re integrated with smart contracts and decentralized applications (DApps), which function like regular apps but instead are run on a blockchain.

Some DeFi platforms have AI agents integrated into them. These agents can work with decentralized exchanges (DEXs) and lending platforms to make trading easier, smarter and safer for users. However, some apps or bots must be downloaded to start interacting with an AI agent. 

For instance, an AI agent could monitor interest rate trends in Aave, optimizing lending strategies. If the interest rates for borrowing assets on Aave drop below a threshold, the AI could automatically rebalance your portfolio, shifting your assets to a more profitable lending market.

In contrast, some platforms offer AI services through subscriptions. You pay a small fee, and the AI takes care of tasks like automatic trading or rebalancing your portfolio without needing you to do anything.

AI agents often work through smart contracts, which are like self-executing agreements that run automatically when conditions are met. There is no need to trust an intermediary; everything is handled by code, making transactions safe and automatic. Here’s how it works:

• Predefined rules: The AI agent interacts with a smart contract containing predefined conditions (e.g., “buy Bitcoin if the price drops to $40,000”).
• Real-time data analysis: The AI continuously monitors market conditions, user preferences or risk factors and feeds this data into the smart contract.
• Automatic execution: When the conditions are met, the smart contract executes the transaction instantly, whether it’s a trade, loan adjustment, or portfolio rebalancing.

Did you know? According to CoinGecko, interest in AI agents has surged, with the market cap of this niche growing by 222% to over $15 billion by the end of 2024. 

Different ways to use AI in DeFi

AI agents in decentralized finance are transforming how users manage their assets, from trading and market analysis to risk management and security. These AI-powered tools enhance DeFi platforms and help users save costs by reducing the need for professional financial firms.

AI agents for crypto trading

AI agents are taking the role of traders by automating their daily routines. While traditional bots follow pre-set rules, AI trading agents learn from market patterns and adapt their strategies in real time.

They monitor price fluctuations of cryptocurrencies, identify trends and execute trades 24/7, ensuring that your portfolio is always managed with up-to-date information. They can spot arbitrage opportunities and optimize buying/selling decisions across multiple platforms.

For example, an AI-powered trading agent might execute complex multi-step trades, taking advantage of price differences between various DEXs and ensuring that opportunities are not missed.

AI agents for risk management

Risk management in the risky DeFi world can be daunting, but AI agents can help manage it. With the ability to continuously monitor market volatility, liquidity, and borrower credit risk, AI agents provide a more accurate and real-time risk assessment than traditional systems. 

In DeFi lending, for example, AI agents examine a borrower’s history on various platforms and offer customized collateral and loan terms based on real-time inputs.

AI agents for crypto market analysis 

AI agents can process vast amounts of data. By scanning the price history of cryptocurrencies, social media sentiment and economic indicators, these agents are constantly learning and adapting to predict market trends. As a result, they can spot emerging trends, forecast price movements and even identify the next big DeFi project.

With this information, traders and investors can stay ahead of the curve, making more informed decisions and avoiding risky markets.

AI agents for enhanced security

Security is one of the significant topics in DeFi, and AI agents can become crucial in helping detect fraudulent activities. They can analyze patterns to identify unusual behaviors, such as rapid, large withdrawals or trades that could signal a breach. 

Furthermore, AI agents can monitor smart contracts to detect vulnerabilities before they are exploitedexploiting them, ensuring the platform’s security.

AI agents for yield farming and staking

As yield farming and staking pools can be highly lucrative, constant monitoring of gas fees, rewards, and interest rates for optimization is required. AI agents are adept at determining the most profitable pools to stake or farm tokens, switching strategies on the fly to compound returns. They can ensure that your assets always work for you, even when you are not actively controlling them.

AI agents as personalized financial assistants

By acting as personalized financial assistants, AI agents can help users navigate the complexities of DeFi. They can suggest the best investment opportunities, provide portfolio advice and help users optimize their assets while saving costs — without requiring in-depth crypto knowledge.

Additionally, some agents can assist with taxes and financial research, making it easier to navigate the accounting field. This creates a more inclusive DeFi ecosystem where newcomers can participate and make informed decisions.

Let’s focus on creating an AI agent for portfolio management in DeFi. This AI agent will help manage and optimize your cryptocurrency holdings in a decentralized way.

Did you know? In decentralized autonomous organizations (DAOs), AI agents can be leveraged to provide data-driven feedback and recommendations on governance proposals. From processing onchain information, sentiment within the community, and economic statistics, such agents help DAO participants make more informed decisions.

AI agent for portfolio management in DeFi: Step-by-step guide

This section explains how to create an AI agent for DeFi portfolio management that autonomously optimizes asset allocation, rebalances holdings and leverages yield farming opportunities through smart contracts.

Step 1: Define portfolio management goals

Start by defining what you want your AI agent to achieve with your crypto wallet. Common portfolio management goals include:

• Rebalancing: Ensuring the portfolio stays aligned with the desired allocation (e.g., 50% Bitcoin (BTC), 30% Ether (ETH) and 20% stablecoins).
• Risk management: Adjusting allocations based on market conditions or volatility.
• Diversification: Ensuring the portfolio is spread across a variety of assets to minimize risk.
• Yield optimization: Allocating assets to maximize returns through yield farming or staking opportunities.

Your AI agent will analyze your portfolio and automatically rebalance it on a regular basis every month to keep your crypto allocation within the desired percentages, adding stablecoins when volatility is high or increasing exposure to promising altcoins during a bull market.

Step 2: Choose the data

Your AI agent will need market data to make informed decisions. For portfolio management, the data includes:

• Price: Real-time and historical data of various cryptocurrencies.
• Market conditions: Volatility, liquidity, market trends, etc.
• DeFi opportunities: Information about yield farming, staking and lending rates.
• Risk metrics: Data on market risk and volatility levels.

Use APIs like CoinGecko or CoinMarketCapto to fetch real-time price and market data. Get information on available yield opportunities from Yearn.finance or Aave.

Step 3: Build or choose an AI model

For portfolio management, a reinforcement learning model might be most appropriate. The AI will learn and adapt its actions based on rewards or penalties. This allows the agent to optimize the portfolio over time by evaluating the performance of different assets and adjusting allocations accordingly.

• What the model does: The AI learns from past portfolio performance and current market conditions to suggest the optimal mix of assets.

The AI will monitor market fluctuations, adjusting asset allocation by moving funds into stablecoins during high volatility or switching into high-yield opportunities when market conditions are favorable.

Step 4: Develop smart contracts for automation

To implement portfolio rebalancing and other tasks autonomously, write smart contracts to handle actions like swapping assets, staking or yield farming based on the AI’s recommendations.

• What the smart contract does: The smart contract will handle transactions like moving assets between wallets, rebalancing portfolios, staking tokens or withdrawing funds from yield farming pools.

So, write a Solidity smart contract that automatically moves your holdings based on the AI’s instructions. For example, if the AI detects that your portfolio has too much ETH and insufficient BTC, the smart contract will automatically swap some Ether for Bitcoin.

Step 5: Integrate AI with the DeFi platform

Use a blockchain interaction library like web3.js or ethers.js to connect your AI with the DeFi protocols. This allows the AI to send transactions to DeFi platforms like Uniswap or SushiSwap to swap tokens, Aave for lending/borrowing or Compound for yield farming.

The AI could determine that a particular stablecoin pool offers the best yield and instructs the smart contract to swap a portion of your crypto holdings for the stablecoin and stake it in the pool.

Step 6: Backtest and optimize the strategy

Before deploying the AI agent, backtest it using historical data to simulate how it would have performed under various market conditions.

• Backtesting: Run the AI model using past market data to see how it would have adjusted the portfolio.
• Optimization: Adjust the model based on backtesting results to ensure it meets your portfolio goals and risk tolerance.

You could run the AI agent with historical data from the past two years, simulating market crashes and rallies, to see how well it rebalances the portfolio and minimizes losses or maximizes gains.

Step 7: Launch and monitor the AI agent

Once the AI is trained and the smart contracts are deployed, you can launch your AI-powered portfolio manager.

Regularly check that the AI performs as expected and that the smart contracts execute correctly. You can set up alerts for significant changes or portfolio adjustments.

For instance, you might want to monitor how often the portfolio rebalances, ensuring the AI isn’t making unnecessary changes or accumulating high gas fees due to frequent swaps. You can also track the performance of your yield farming and staking efforts.

Drawbacks of AI agents 

While AI agents in the crypto space are gaining traction, much of the current excitement remains speculative. Researchers caution that many AI agent projects have yet to prove their utility beyond hype.

One of the biggest concerns is their reliance on real-time, high-fidelity data. Errors or data manipulation can lead to unintended decisions with serious financial consequences. 

Mike Cahill from the Pyth Network highlights that AI agents require ultra-low-latency price updates, ideally sourced directly from first-party providers like exchanges, to reduce risks from outdated or manipulated data.

While interest in AI-related crypto projects has surged, much of the AI agent niche remains speculative. Although some projects address practical challenges, the rapid development of Chinese AI models also adds competitive pressure that may lead to a sell-off among crypto AI projects, according to Sygnum Bank.

Additionally, while AI enhances security, it also introduces new risks. If not properly secured, AI systems can become targets for malicious actors. Moreover, flaws in algorithms could be exploited, making security a top priority for any AI-powered DeFi platform.

The regulatory environment of AI in DeFi is still nascent. Regulators and governments are concerned about algorithmic bias, data privacy and accountability. Resolving these concerns is crucial for AI to be implemented in DeFi on a large scale.