Decentralized Finance (DeFi) is being discussed by lots of people interested in its innovation. This is because there are many opportunities to explore in this resourceful space. It creates a unique system of carrying out financial services for users, especially those who long for high returns on their investments.
It provides attractive opportunities which vary from earning passive income and high-interest rates.
However, it is not a get-rich-quick scheme, but instead, a safe strategy to extensively increase your yields or investments. DeFi ecosystem is a growing operation that is gaining more adoption in the crypto space.
Currently, many individuals and even high-profile companies are recognizing the privilege and advantages of utilizing DeFi services. In this guide, we will discuss four methods of generating a passive income in DeFi.
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What is DeFi?
DeFi, an acronym for Decentralized Finance is a system built on the blockchain which provides varieties of financial services for users. DeFi provides a range of financial services just like the banks but in a more refined and decentralized way.
This new finance system appears to possibly be the finance of the future, as most people want to have 100% control over their money.
DeFi made it easy for users to freely access and manage financial services with little or no limitations and no intermediary is needed. Users can borrow or lend crypto assets, get insurance, receive interest in their investments, and much more without any restrictions.
One impressive benefit of DeFi is its availability to everyone. Anyone can easily access DeFi products or services as long as you have a crypto asset. There are no requirements for identity checks or verifications like it’s done in banks. All you need is a wallet funded with crypto to access these DeFi protocols.
However, you will need a lot of patience to be able to acquire and grow your income. With a sure income, you won’t fret in market dips, because there are other means for you to keep earning even in the crypto market storm.
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Ways to earn passive income from DeFi
There is a possibility to earn a passive income from DeFi, with never-ending opportunities spread in various protocols and platforms.
You can accumulate profits through lending, providing liquidity, staking, and yield farming.
1. DeFi Lending
Lending your cryptocurrency is one of the simplest ways to make money in the DeFi space. This concept allows investors to lend their crypto assets out to other individuals who are the borrowers, after which they receive some interest in return.
In the traditional finance system, we borrow money from banks to buy cars, houses, and so on. But, there is no opportunity to lend our money to others to gain some interest.
DeFi with the use of smart contracts makes it easy for users to lend money on a lending platform. Users who want to borrow on the platform, place another crypto asset that serves as collateral. For example, you can deposit ETH to borrow USDC. Here ETH serves as the collateral.
However, the interest being paid to the platform by the borrowers is allocated to the lenders. As a lender, you can withdraw your money anytime if you are done with lending. No restraints on how long you can lend your assets on the platform.
The interesting part is, that you can lend several crypto assets; but lending stablecoins is recognized to be safe (minimum risk) and more stable since it is pegged to fiat currency.
Three famous DeFi lending platforms are Aave, Celcius, and Compound. They specify their lending rates on the platform; some rates of a particular coin can be over 30% APR(Annual Percentage Rate) while some others can be close to 0%.
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2. Providing Liquidity
Liquidity providers are DeFi users that fund crypto assets in liquidity pools which are controlled by smart contracts. They facilitate trading on platforms and generate payments on their asset deposits. Payments are made based on the percentage of liquidity each user provides.
A liquidity pool is a smart contract that contains crypto funds; this pool powers the marketplace where users lend, borrow and exchange crypto assets.
During pool funding, users fund two different crypto assets to enable traders to swap and trade between the token pairs.
For example, a liquidity provider can deposit in a liquidity pool $10,000 worth of ETH and $10,000 of USDC which allows trading and swapping between the token pairs. In doing so, whenever ETH/USDC trade is executed by the smart contracts, payment would be made to the people that provided liquidity in the pool.
The percentage fee you earn from swaps of the token pairs depends on the pool you funded. Also, the more the pairs are being traded in the pool, the more income you will earn.
Liquidity providers are viewed as trade facilitators as they enable trades by funding the pools.
The downside of providing liquidity;
Impermanent Loss is the risk identified in providing liquidity. Impermanent loss is when one of the tokens you provided in the pool fluctuates in price.
Profits are not constantly ensured when providing liquidity as the crypto market is volatile, you can lose money by impermanent loss. However, this loss can be avoided by choosing more stable and less volatile assets with high liquid pools.
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Staking is a popular and interesting method of earning passive income in DeFi. Many investors who have not explored the DeFi space are familiar with the concept of staking, probably because it is executed on many well-known cryptocurrency exchanges.
The term staking is the process by which investors lock their crypto coins into a smart contract and in return, they earn more of the same crypto coin as a reward for contributing to the network.
Technically, this technique which is known as a proof-of-stake mechanism is employed to validate transactions and aid the operation on the blockchain. The process is automated as it doesn’t need to be supervised manually.
Staking is practically a way investors can earn interest in their crypto. It is a safe way of generating profits even during market dips. Stakers can lock up their crypto for a long period and earn profit. Hence, you can unlock and withdraw your staked assets at any time.
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4. Yield Farming
Yield Farming also called liquidity mining, is another way you can earn passive income in DeFi by locking your crypto assets and receiving profits in return. This process is similar to “staking” described above, but the scheme behind it is more complex when compared to staking. Yield farming requires liquidity providers to fund a liquidity pool.
When you provide liquidity in a pool, you receive rewards for funding the pool. These rewards can furthermore be locked into yield farms to earn more of the same token or different tokens. This means that while your assets in liquidity pools are earning rewards, your rewards can also be deposited in other liquidity pools to earn more rewards.
However, It’s important to research the platform when trying to earn rewards in yield farming, to ensure the platform is well maintained.
DeFi is a finance system with lots of opportunities it offers to its users around the globe. This is a space where anyone can partake in depositing, lending, borrowing, and executing transactions without any third party. However, to earn extensively and obtain massive opportunities, users need to be well experienced in this space.