This guide will explore “How to earn passive income in DeFi in 2022“. DeFi stands for Decentralized Finance.
DeFi has disrupted the way the finance industry works. It encompasses a range of financial applications built on top of blockchain platforms. These financial applications automate (Smart Contract governed) the financial transactions like money transfer, lending, borrowing, crowdfunding and more. Hence, DeFi eliminates the need for intermediaries like banks and other financial institutions.
Over the past few years the total value locked for DeFi has risen from a mere $1 billion to a staggering $66 billion as of today.
In this guide “How to earn passive income in DeFi in 2022”, we will explore the best ways to earn money in the DeFi space. We will also try and uncover the Principles or Strategies of investing in DeFi? We will try and answer the questions “Is DeFi investing safe in 2022?”, “What are the various risks involved in DeFi investments?”,” What are the measures to mitigate these risks involved in DeFi?”
Let us begin, unwrapping the concepts one by one. But first, let us decode the term DeFi.
Table of Contents
What is DeFi?
Simply put, DeFi or Decentralized Finance is referred to the ecosystem of financial applications built on top of Blockchain technology.
Much like the traditional Centralized Financial (CeFi) systems, the DeFi applications provide services like loans, insurance, lending and borrowing, derivatives, crowdfunding, bonds, etc.
In the CeFi, all the transactions which take place, are verified and recorded by Centralized institutions like banks and other financial institutions like PayPal, Paytm, etc. For instance, if you want to send money to your friend, it will not be a peer to peer process. The banking institutions of your friend and yours will intervene to facilitate the transaction. These two banks will verify and record the transaction and hence will charge a transaction fees.
However, building these financial applications on top of a blockchain platform eliminates the need for any third party such as banks, financial bodies, etc. to verify and record transactions.
The primary motive of a DeFi is the elimination of any third parties to record and verify financial transactions. Money or value should be sent directly from one person to another without getting any third party involved.
A popular use case of DeFi is a lending application which connects lenders directly to borrowers. No third parties are involved hence no extra transaction fees are incurred. Lenders, lend crypto money directly to a borrower which the borrower can exchange for any fiat currency (if required).
Other use cases of DeFi include Decentralized Exchanges (DEX), betting, prediction markets, Stablecoins, etc.
Now that we understand DeFi, let us quickly jump to the primary topic of this guide “How to earn money in DeFi in 2022?”.
How to earn passive income in DeFi in 2022?
Let us quickly go through the best ways to earn passive income in DeFi in 2022.
Trading DeFi Assets or Tokens
One of the most popular ways of earning passive income from DeFi is by trading DeFi tokens. This means buying, selling and holding DeFi tokens at the correct price to earn profits.
Just like cryptocurrencies and company stocks, the DeFi tokens are traded on the basis of speculation. The prices can vary on multiple reasons including the potential of the DeFi application the token represents, any recent malware incidents or hacks (which can create a price plunge for the token), overall sentiment of the investors besides other reasons.
What are DeFi Tokens?
DeFi tokens are native tokens to a DeFi application platforms, which are the enablers of various financial services like loans, lending, insurance, crowdfunding, etc. provided by the DeFi platform.
For example, AAVE is the DeFi token of the Aave DeFi platform (open source liquidity protocol). Aave is a lending and borrowing DeFi application which was initially built on top of the Ethereum blockchain. The AAVE token is used for lending, borrowing and other functions of the DeFi platform.
UNI is the token of the DeFi platform Uniswap. Uniswap is a decentralized exchange protocol built on top of the Ethereum blockchain. It automates the process of exchange of cryptocurrencies. UNI token give governance rights for the Uniswap platform. The more UNI tokens one has, the more will be his say in deciding the path forward for the DeFi platform.
Popular DeFi Tokens
The top DeFi tokens as per the market capitalization can be found here.
The most popular ones include AVAX of the Avalanche platform, DAI of the Dai platform, UNI for the Uniswap platform, LINK of the Chainlink platform and LUNA of the Terra platform.
How to trade DeFi tokens?
DeFi tokens can be bought, sold and traded in Centralized and Decentralized exchanges, just like normal cryptocurrencies like Bitcoin, Ether, XRP, ADA, etc.
Popular exchanges include Binance, Gate.io, Coinbase, KuCoin, Kraken, Gemini, BuyUcoin and many more.
Suggested Decentralized Exchanges (DEX) for trading tokens: Binance, Uniswap, Sushiswap.
Decentralized Exchanges unlike Centralized Exchanges give all the power in the hands of the traders. There is no intermediary to manage the transactions (as it happens in Centralized Exchanges). Instead self executing Smart Contracts (codes) facilitate the trading. Learn more of Centralized and Decentralized Exchanges here.
Centralized and Decentralized Exchanges
Lending
DeFi lending and borrowing platforms allow users to lend cryptocurrencies or stable coins and thereby earn interests.
It works similar to how traditional banks earn interests on the money they lend to borrowers.
However, DeFi lending provides more transparency, access, security and speed of transactions as compared to CeFi lending. Each lending and borrowing transaction is recorded in the underlying blockchain platform which is visible to anyone who joins the network. Anyone can lend and borrow using DeFi platforms. Its not that only banks can lend money to earn interests. Even anyone from anywhere with a crypto wallet and crypto as collateral can connect to the DeFi platform and borrow loan. The elimination of middlemen also speeds up the process.
Users of the DeFi lending platforms can lend directly to borrowers or lock their cryptocurrencies in the liquidity protocol of the DeFi platform. The lenders henceforth earn interests.
Popular lending DeFi platforms
Aave, Maker and Compound, InstaDapp are the most popular lending platforms.
DeFi lending platforms built on top of different blockchain platforms are listed here.
The type of collateral required, the loans sanctioned, interest rates vary with each DeFi lending platform. It is worth researching these platforms before lending or borrowing through these platforms.
Lending platforms like Aave offer both variable and fixed interest rates. Variable interest rates are constantly changed based on the asset’s (crypto) demand. On the other hand, fixed interest rates retain the same rate under all market conditions.
Pro tip: you can use variable interest rates on Aave in a bull market to maximize your profits. Once a bearish phase hits the market, switch to fixed interest rates and stabilize your income.
Staking
In simple terms staking is a process in which you lock your crypto (for a defined term) in a platform like an exchange. In return you earn a percentage return on the cryptos you stake. Staking is done to protect the blockchain platforms and also helps in selecting the next validator of the block in a blockchain. Learn more about staking here.
Popular staking platforms:
Popular cryptocurrencies that are staked include Ethereum, Cardano, Solana, Avalanche, Polkadot, BRISE and more.
Yield Farming
Yield farming is somewhat similar to staking, although it encompasses much more.
In simple terms yield farming is a type of investment in which the investors lock their cryptocurrencies in a DeFi platform and hence earn an interest over it.
The concept is simple, although the approach adopted by yield farmers is complex to attain maximum returns. The yield farmer optimizes his/her returns over the year by switching or hopping over to different DeFi platforms basis the return offered by these platforms.
We need to understand two jargons- Liquidity Protocols and Liquidity Providers, in order to understand yield farming better.
A liquidity protocol or a liquidity pool is a digital treasury of cryptocurrency funds locked in a smart contract in a permissionless environment.
So who uses these funds?
These funds are the backbone of Decentralized Exchanges like Uniswap, PancakeSwap, etc. The Decentralized Exchanges use the funds in the Liquidity Pools to match the buy, sell, lend, borrow orders in these platforms.
Now who deposits or locks funds in these Liquidity Pools?
Liquidity Providers lock their funds in these Liquidity Pools and are hence paid an interest which is proportional to the total value locked by the Liquidity Provider.
So in a nutshell, yield farming is an option given to investors to HODL (jargon used in cryptocurrency space for HOLD) their cryptocurrency. Rather than just keeping their cryptocurrencies in their hardware and software wallets, they can stake or lock their cryptocurrencies in a liquidity pool to earn interests as more cryptocurrencies. They can further stake the earnt cryptocurrencies to other liquidity pools to further earn interests.
Popular DeFi applications for Yield farming are Compound, Aave, Curve Finance and Badger DAO.
FAQs
Which blockchain platforms are used for DeFi development?
The blockchain platforms used for DeFi development are:
Ethereum
Solana
Cardano
Polkadot
Avalanche
Polygon
Conclusion
DeFi has seen tremendous growth in participation over the last year. Though it is still at its nascent stages the DeFi crypto market cap is $58.15B as of today (at the time of writing this guide).
DeFi has been seen as a tool to generate high yields but at the same time involve risks like lack of knowledge of the tool, smart contract failures, regulation challenges and more. As the DeFi space will evolve these challenges specially at the technical and regulations side will get remarkably reduced.
This guide “How to earn passive income in DeFi in 2022” shares some of the most popular ways of earning passive income from DeFi.
But it is equally vital to learn the fundamentals, do proper R&D before getting into this space of investing.
This guide is not an investment advice. Please undergo proper research before investing in cryptocurrencies.
Disclaimer
If you are sincerely looking forward to invest in cryptocurrency space and hold the investments for long, use a hardware wallet like Ledger or Trezor. These wallets store your cryptocurrencies (keys to cryptocurrencies) in an offline environment which is therefore cannot be the victim of an online hack or malware practice. Storing your digital assets in an Exchange or software wallet often attract online attacks and malwares.
Word of Advice
