Decentralized finance (DeFi) has opened up a whole new world for people who haven’t seen returns for decades in traditional finance. There are a lot of ways to make passive income with DeFi, and there are a lot of opportunities in this exciting space of platforms, protocols, and exchanges that are always changing. But this new place to test doesn’t come without dangers, and you’ll need a steady hand to get around them. We’ve broken down the process into its main parts to help you find your way.
If you put crypto in DeFi, you’ll get an APY
The easiest way to make a passive income with DeFi is to put your cryptocurrency on a platform or protocol that will pay you an APY (annual percentage yield) for it. This is almost the same as how you would put money into a savings account at a traditional bank, though most of the developed world no longer has interest rates because central banks have printed so much money over the past ten years.
You can use a wide range of coins and tokens to deposit on a DeFi platform, but you can’t use cash (traditional currency). So, your first step will be to use a fiat on-ramp to buy some cryptocurrency (i.e. buying crypto with cash). Before you buy your crypto, though, you should know that Bitcoin (BTC) is usually not accepted because most DeFi runs on the Ethereum blockchain and not on Bitcoin.
Pick a token and a protocol.
To get an APY from most DeFi protocols, you will need to deposit an Ethereum (ERC-20) token. This could be Ethereum’s native currency, Ether (ETH), or, more often, a stablecoin like DAI or USDT, since you don’t have to worry about market volatility. There is also a version of Bitcoin based on Ethereum called wBTC. Its price is tied to the price of the biggest cryptocurrency. To figure out which coin or token you want to put money into, you might first look at the different rates of return for each asset.
Over the past year, DeFi has grown, which has led to a lot of different protocols. It can be hard to know which one to use. The “Earn Income” tool on DeFi Pulse lets users search for platforms by asset, which is a good place to start. Once you’ve decided which token you want to deposit, you can buy and sell it on a centralized or decentralized exchange. There are now many aggregators, such as 1inch, that can help you find the best exchange rate for your cryptocurrency.
How to Mine Liquidity
Even though it’s great to earn interest on your assets, that’s not all you can do in DeFi. The next step on the path to passive income is to start liquidity mining, also called “yield farming.” There are a few ways to get started. The first could be to bet on or trade any rewards you get for depositing your cryptocurrency. These rewards are usually the native token of the protocol or platform where you deposited your cryptocurrency.
Most of the time, the people who own these governance tokens get to vote on changes to the protocol. Because of this, many of them are valuable on the secondary market. You usually have two choices with these tokens: stake them with the protocol that gave them to you for more rewards or trade them on an exchange (DEXs like Uniswap will have all of them listed, while some centralized exchanges support the most popular ones). You might decide to trade a token because you can exchange it for a stablecoin that pays more interest.
Boost with loans and borrowing
You can also get passive DeFi income by borrowing tokens or coins from a platform and then putting them back into the same platform or another platform to get rewards. For example, if you own Bitcoin, you could swap $1,000 worth of BTC for wBTC and then put that into a DeFi protocol for an APY of 0.5%. This is a small return, but because you put up that BTC as collateral, you can borrow up to 75% of the value of your BTC ($750) to buy another coin or token with a high return.
Then you can take that loan and put it in the bank or lend it out. By doing this, you have freed up another 75% of the value of your BTC, which you can now use to make more passive income. In the meantime, you keep getting interest and native/governance tokens that you can stake with the platform or trade on a DEX to take part in more liquidity mining.
Passive income pitfalls
The above process can technically go on forever, which is what makes the DeFi ecosystem so complicated. In fact, what we’ve talked about so far is just the tip of the iceberg when it comes to what experienced users can do in DeFi, where leverage and derivatives can be used to increase returns by up to 15 times. As you might expect, though, all of this comes with risk, and the risk can be very high for people who do multi-layered liquidity mining.
Users with assets on multiple platforms face a number of risks, including the possibility of losing them due to smart contract exploits (also called “flash loan hacks”) and having to pay high transaction fees (called “gas”) when the Ethereum network is busy. These fees can eat up a lot of your profits. A big problem can also be temporary loss, which happens when the price of your assets goes down while they are deposited with a protocol. Also, since interest rates change every day and often go down as more people join, locking your crypto in a protocol that doesn’t pay enough could cost you opportunities.
It doesn’t have to be hard to do DeFi.
In short, if you want to earn a passive income through DeFi, you need to have a lot of experience and usually a lot of money so you can take advantage of high-volume opportunities and be able to handle losses. And, most importantly, this is a far cry from what DeFi was supposed to be when it started. It was supposed to be a place where anyone could deposit, borrow, and lend money to make money, which has been the domain of wealthy people in traditional finance for a long time.