DeFi is the market of the moment. Not surprisingly, despite being only in its infancy, the current value is over $40 billion. Why so much fame in such a short time? Well, DeFi represents the most modern form of financial services, and its main feature is that it is completely decentralized. This means that there is no intermediary such as banks, institutions or government bodies.
Almost all of DeFi's protocols run on Ethereum's blockchain. However, the main reason why it is so much in demand is the possibility to implement numerous attractive earning strategies by leveraging the ecosystem offered by Ethereum. If you are not yet familiar with the world of DeFi, check out our in-depth Italian guide here.
What are the main passive income strategies?
Before we delve into the many strategies for earning money through the DeFi protocols, it is important to make a small disclaimer and point out that, regardless of its safety, every investment always has a higher or lower level of risk. The advice, therefore, is to invest only what you are willing to lose, and not the entire capital you have available. The earning strategies listed below are shown for explanatory purposes only, and follow an objective analysis aimed at sharing information.
Back to us, DeFi offers decentralized financial services whose functionality cannot be changed. The contracts (smart-contracts) remain unchanged on the Ethereum blockchain, and are accessible to anyone under the same conditions. In this sense, it is possible to access earning strategies that, in the long or short term, can be very profitable, namely: Staking, Lending, Liquidity Providing, Farming.
Staking
As many of you know, staking is nothing but a process comparable to mining. The main difference is that staking is based on Proof of Stake (PoS), while mining is based on Proof of Work (PoW). With staking, each participant holds his own coins within a wallet, helping to improve the security of the network by keeping it decentralized. In turn, staking is divided into staking of ETH 2.0 and ERC-20 tokens. Let's look at the differences together.
Staking ETH 2.0
ETH 2.0 staking is perhaps one of the most recent earning strategies, and has also been made available by exchanges such as Coinbase. The operation is very simple: you deposit Ethereum in a portfolio and you start earning interest passively in percentages that fluctuate on average around 8% APR (Annual Percentage Rate). The advantage is that it is, in fact, one of the latest HODLing strategies in circulation and it is very popular among users.
Also, you can participate in staking pools via exchanges such as Binance, where users pool their cryptos together so they can have a better chance of winning the reward randomly given by the Proof of Stake. However, risk is always around the corner, as staking provides for an indefinite lock on your cryptos, and other users may illicitly seize your assets. Anyway, ETH 2.0 staking is among the most popular strategies of the moment.
Staking ERC-20
Staking ERC-20 tokens works exactly the same way as ETH 2.0, the only difference being that you'll have to deposit a different type of asset. You can use tokens such as Synthetix, Sushi, Aave, The Graph, Badger, and many others, each of which will grant different interest percentages based on the conditions of the blockchain. To get an idea of the APR percentages available, you can use platforms like stakingrewards, where you can monitor in real time the rewards offered by the network. In general, these range from a minimum of 3% to a maximum which, at the time of writing this article, can be as high as 134% APR for assets like PancakeSwap.
Lending
Lending on DeFi protocols is also divided into two different parts, just like Staking. We can speak, in fact, of Lending of stablecoin and Lending of ETH, Wrapped ETH and Wrapped BTC. Lending refers to the act of lending one's coins to beneficiaries, earning interest on one's coins. There are already CeFi platforms offering similar services, but interest in DeFi protocols is definitely more exciting, especially for stablecoins.
Lending stablecoins, in fact, you can enjoy an interest that varies from 3% to 30% APR depending on market demand. During bull markets, for example, the gain rises dramatically, while in bearish periods the interest drops a bit. This is a totally passive strategy, the cons of which are very subjective. In fact, having a stable value, in bull periods you could lose interesting gains, even if in bearish periods you can save yourself from important losses. The only perennial risk is the possible fall in value of a stable currency such as the euro or the dollar.
Taking advantage of Wrapped ETH and Wrapped BTC lending, on the other hand, gives you access to relatively low interest rates, ranging from 0.15% to 3% APR. However, for stubborn HODLers, this can be a great opportunity to gradually grow your portfolio.
Liquidity Providing
Liquidity Providing literally means providing liquidity. Let's try to explain it a bit better by quoting below an example from Binance Academy where the concept of liquidity is explained in a simple and intuitive way.
"Bob has 5 tokens of a certain cryptocurrency, the price of which has increased in the last few days. Bob is satisfied and decides to quickly sell all his tokens at the current market price.
If the market is liquid, that is, if there are enough buyers willing to buy Bob's tokens at the price he has set, Bob is able to sell his assets quickly and at the price he wants. Bob's trade does not affect the price of the token as there is sufficient liquidity to execute the trade."
It is possible to take advantage of the Liquidity Pools offered by the DeFi protocols, which automate the liquidity process by facilitating exchanges and offering attractive rates to providers. Let's take a practical example. You deposit tokens worth $1000 into a Liquidity Pool for the ETH/USDT pair. Your asset will be locked in at a 1:1 ratio valued at the time of deposit, and you will be entitled to earn fixed commissions per trade (around 0.3%) also based on the amount of liquidity you are providing.
The advantages, of course, are many, such as being able to generate really high commissions if you participate in a high-trading market, and the possibility of receiving interest boosts thanks to bonuses offered by providers or the dApps themselves. However, in case the market value collapses, you could incur permanent losses. Nevertheless, it is interesting to note that the APR for Liquidty Providing on DeFi protocols can also reach 100% without counting any rewards and bonuses.
Farming
Farming is undoubtedly one of the most profitable earning strategies when it comes to the DeFi industry, especially if we are talking about short-term investments. Unlike the other methods seen so far, Farming, and more precisely Yield Farming, is a method that allows you to enjoy not only high interest rates, but compound interest that makes your portfolio soar.
If you want to get compound interest through staking, for example, you have to continuously withdraw and re-deposit your funds by interacting with the smart-contract. This, of course, has significant costs, which would risk rendering all our efforts null and void. Yield Farming, on the other hand, not only ''nurtures'' earnings by removing transaction fees, but also rewards in some cases by creating compound interest (APY) that can reach as high as 100% in a very short period of time.
However, some assets are suddenly created and disappear, causing permanent unrecoverable losses. Also, the advice is to think short-term when implementing these earning strategies.
Conclusions
The world of DeFi is waiting to be discovered, as it offers financial services that are totally changing the way we make investments.
If before we were used to depositing our money in the bank with paltry interest of less than 2%, today it is possible to take advantage of innovative solutions that can generate huge profits.
Obviously, the ground must be surveyed before walking on it, and it is highly inadvisable to deposit money in something you don't know thoroughly.
I gave you the tools. Now it is up to you to use them in the right way. To do so, the advice is always to keep yourself updated!
*This article was posted on theledger.it following our schedule in Italian language. Just check them if you want to support our work :) You can check the article here.
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Learn More
- https://theledger.it/news/coinbase-staking-per-eth-2-0/
- https://theledger.it/guide/defi-finanza-decentralizzata/
- https://theledger.it/approfondimenti/cefi-le-banche-del-futuro/
Bibliography
- https://it.cointelegraph.com/explained/ethereum-20-staking-explained
- https://www.reddit.com/r/ethereum/
- https://www.stakingrewards.com/defi
- https://academy.binance.com/it/articles/liquidity-explained
