Once upon a time, we would usually deposit money into a bank and let it “grow”. Even if it was measly 0.10% interest, at least it’s “free” money. Banks used to use our money, profit off of it, and then give us whatever they want.
Decentralized finance (DEFI) has changed all that and we will dive deeper into that within this article. For now, let’s focus on traditional banks, traditional banks never really cared about us.
Our accounts are attached to an ID with other metadata such as name, amount, and other metrics they used to track us.
It was basically a black box that we used to store our money. If you met a certain criterion in terms of wealth and status. You are opened to programs that wouldn’t normally be accessible to someone from a lower socio-economic background.
These programs are where the real money can be made. If you want to borrow a loan, the process can be long and drawn out. Depending on the loan and your socio-economic background, if you do get the loan at the end, you are basically now a debt slave due to the amount of interest you have to pay back.
Depending on the geographic location of where you are, they are always the slowest to innovate.
Introducing Decentralized Finance
Decentralized finance spun out of the cryptocurrency movement which has engulfed our modern society. Love it or hate it, it’s the future and if you fail to participate in it, you are missing out on opportunities that only come around every couple of decades or century.
When it comes to cryptocurrencies, most of the population only slightly know what Bitcoin is. They see it as digital money and a get-rich-quick scheme. I have to blame marketing for this, but bitcoin is just the tip of the iceberg.
Underneath is a whole new landmass yet to be discovered and for the very few that are brave enough to venture out within the wild, they are reaping the benefits. It’s only a matter of time before banks start adopting some of these technologies that I will talk about shortly.
Now let’s continue from where I left off, Defi changed the entire landscape of cryptocurrency and made Bitcoin itself, look like a mere artifact of the past.
Originally cryptocurrencies had just a handful of use cases: purchasing items, sending money to any address in the world without any middlemen and miners could mine for more bitcoin. Now we are open to a whole ecosystem of financial products and services.
Why invest in banks that are giving you 0.01% APY (Annual Percentage Yield) on your money when certain Defi protocols can give you up to 10%. I know it sounds too good to be true, but you can check out the rates of the different Defi protocols if you want.
Earning Money With Decentralized Finance
It’s quite possible to earn money with Defi, even if you are a low-risk individual there are different ways that you can make money within this space passively. You can try yield farming, lending, staking, and becoming a liquidity provider. You also have other exotic ways but those are not beginner-friendly and you need a certain amount of capital to make it work.
I will try my best to go into each and every one of the four ways you can earn passive income from Defi. You will have to do your own due diligence as always and learn more about these protocols and systems online as things can change so quickly.
Staking
Staking is a viable option for persons who want to earn passive income with Defi. Basically, with staking, you are locking your money up into a smart contract to earn more of the same native token.
For example, if you should lock your token up in an Ethereum or Solana smart contract such as a wallet, you will then be rewarded for such an activity in that native token such as Ethereum or the tokens related to that smart contract.
Similarly, to a bank, where you would deposit your money and get rewards in “interest” for your action, you will be rewarded here and it can prove to be profitable if you know where to look.
Staking came out of the philosophy of proof of stake algorithms and it’s very similar to how we view a bank. For example, typically we normally flock to large banks because they are “perceived” to be secure as they have a large customer base.
This gives us reassurance that, if others are doing it, probably it’s trustworthy enough for me to put money within that particular bank as well.
In the crypto world, the more money locked into a smart contract, the more valuable it seems for others to lock money in the platform because it seems like it’s safe for others.
The platform will then reward those users who have “staked” their tokens within the protocol. As you can see, otherwise from earning money, staking is fundamental to a defi project.
Furthermore, staking can give you governmental privileges on the platform, the more you stake on the platform is the more privileges you will receive as you are now a part of that ecosystem.
Users who typically have the most staked on a platform will be given the option to validate transactions on the network.
Lending
Lending is also one of the easiest ways you can get into defi and it’s pretty self-explanatory. You are basically going to lock your tokens within a platform and allow borrowers to come in and borrow money based on some rate.
Typically, borrowers would’ve skin in the game and have to offer some form of collateral just in case things turn south. Once the deal is paid back, you will earn interest based on the amount you locked into the smart contract. Keep in that other users will be lending digital assets as well so it will be some sort of asset pool.
As a beginner, lending is probably one of the first places to start when you want to grace the defi space. It’s pretty straightforward and you can take your assets out at any time.
The interest rates offered by lending platforms are even better than traditional banks, for example, Celsius which is specifically for defi lending will give you a 6.5% interest if you lend Bitcoin.
Become a Liquidity Provider
CEXes VS DEXes
A liquidity provider is a concept that I really liked as it shows the possibility of decentralization. In the defi world, you have two types of exchanges, Centralized exchanges (CEX) and Decentralized exchanges (DEX).
Centralized exchanges would be Coinbase, Binance, FTX, etc. These are prone to manipulation and despite the fact that they are participating on their platform, they come with the same centralized issues, we face in the real world: control, censorship, etc.
On the other hand, you also have decentralized exchanges such as Curve, SushiSwap, PancakeSwap, dYdx2, etc. These models are the inverse of centralized exchanges in most cases.
Centralized exchanges depend on algorithms ran on servers to make deals and match demand and supply. Dexes on the other hand connect sellers and buyers together.
If you want to trade new cryptocurrencies before they hit centralized exchanges, you would typically use a decentralized exchange. It would have to go through too many due diligence tests before it hits the wider market on a centralized exchange.
Lastly, with DEXes the data cannot be easily faked such as volume, you can view the data as it is all opened to the public.
Bottleneck and Opportunity
The only drawback for DEXes is the reason why your precious tokens are so important. Centralized exchanges typically have a better liquidity pool system than decentralized exchanges.
A liquidity pool is basically the oil that keeps the engine going, without that the system goes bust. In the real-world market makers such as banks and other large financial entities would control the liquidity pool. They would be the ones that would ensure that you can sell and buy securities.
On DEXes it is a much different story, because of the decentralized factor, they depend on users to become liquidity pool (LP) providers. These LP will now be rewarded for their “good” deed in LP tokens or LP provider tokens.
The earnings you will reap are normally from the revenue generated from the platform. The party stops here though and continues reading to see why.
Automated Market Maker and Risk Assessment
Even though DEXes provide a way to earn reward tokens and the APY can tend to be higher, risks are still involved. It starts from the central mechanism that powers decentralized exchanges, these are called automated market markets (AMM).
AMM basically is not an individual but an algorithm that maintains the liquidity on the platform.
They are there to facilitate the automated and decentralized aspect of the platform. AMMs ensure that users are trading tokens at market prices.
One of the main drawbacks of AMM is impermanent loss Impermanent loss is when your tokens are exposed to shocks outside of the platform. Hence, there can be situations where you withdraw less than what you deposit based on the cryptonomic climate.
For example, let’s say that for hypothesis, Solana is worth $100 a token, and you put up 10 Solana as a liquidity provider at $1000. You will also be depositing $1000 in USDT (United States Dollar Tokens). Overall, you will have $2000 in the platform.
2 weeks later, Solana is up 100%, if you withdraw you would receive $2800. You would earn a cool $800 extra, that’s a good return but you missed the opportunity cost of just “hodling” your tokens without having them locked up in the liquidity pool.
You would’ve earned an extra $1000, so the overall total would be $3000. This calculation is based on DEXes where you would’ve to deposit 50/50 pairs. if you deposit $100 Solana, you would’ve to deposit $100 of some other token. You also have other algorithmic AMMs that have a different ratio.
Even though the impermanent loss is an issue. It can be mitigated by fees. Decentralized exchanges use fees as a way to reward users and help them to navigate the uncertain waters of becoming a liquidity provider.
Yield Farming
Yield Farming is similar to staking. You would lock up your digital assets within a Defi protocol and reward in the end. Rewards can come in tokens, percentage of revenue generated, or even governance tokens.
These protocols are normally liquidity pools run on smart contracts. Returns are based on an Annual Percentage Yield (APY).
The number of investors on the platform also affects the APY. The more they are the less APY you would receive. Yield is also within the same realms of being a liquidity provider as you are providing liquidity within the Defi protocol and is being rewarded. You can look at it as a mixture between being a liquidity provider and staking.
Wild, Wild, West and Due Diligence
Now that you have found out about some of the different ways you can earn passive income from Defi. It’s now up to you to do your research on the different protocols available and your own due diligence.
The crypto field is always changing, hacks and scams are now commonplace but don’t let that deter you. In the real world, you would be amazed at how many scams are around if you look hard enough. Especially within banks and corporations.
It’s even worse than crypto, but that’s for another topic. The only difference is that cryptocurrencies are run on the blockchain. This can be visualized as an open database similar to an excel spreadsheet.
So, you can view the transactions. It’s still not enough to prevent these scams. Anyone can “copypasta” code off of GitHub and build their own tokens and protocol too.
If you want to look at the viability of a token, you can use a token sniffer, to help you. I use this a lot to analyze the risk of different tokens and their usability. You can also read whitepapers on the protocol to see if it’s useful. It can be found on their website or on a database such as whitepaperdatabase.
The information is out there guys, you just got to research. Go on YouTube, research online, ask persons within the space on social media who are reputable and if it smells like shit to you, it probably is, our risk tolerance is all different. Take care.
