Decentralized Finance or DeFi has many favorable propositions for any beginner to start participating in the newly evolving ecosystem. In addition, the most striking aspect with DeFi directly points out the opportunity to earn passive income with DeFi. Users can commit their crypto assets to secure decentralized protocols in return for passive income on the deposited assets. In recent times, crypto owners have been turning towards passive income generation techniques for extracting value from their assets.
Many new types of DeFi passive income generation methods have emerged in three years since the inception of DeFi. You can find various decentralized protocols and smart contract applications in the DeFi landscape, offering exclusive ways for passive income. The following discussion aims to introduce readers to four common methods for earning passive income in DeFi, which you can employ for deriving additional value from your crypto assets.
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Using Your Assets for Passive Income in DeFi
The most interesting aspect of decentralized finance or DeFi is the opportunity for any individual to access the ecosystem. On top of it, you would find key features of DeFi which establish it as a unique intervention in finance. With a diverse assortment of value advantages as well as risks in DeFi, it has birthed many new possibilities for income generation. The decentralized traits of DeFi ensure that participants can interact with financial products and services in a variety of ways.
Furthermore, the DeFi ecosystem is also expanding continuously with every passing day. Therefore, DeFi is creating new perspectives on how to invest in DeFi for favorable returns. Interestingly, DeFi users don’t have to go through any complex measures for earning passive income with DeFi. You can use your digital assets to earn passive income in DeFi with methods like staking, yield farming, and lending.
Methods for Earning Passive Income in DeFi
If you are seeking answers to “how to earn passive income with DeFi,” then you might find them easily. The evolution of DeFi has simplified financial services alongside the process for earning favorable returns on investments in digital assets. However, you should also remember that DeFi does not offer any ‘get-rich-quick’ schemes for growing the value of your assets.
You need comprehensive awareness of topics such as automated market makers or AMMs and the basics of blockchain. In addition, you should also have a clear impression of the ways of interacting with crypto wallets for employing DeFi passive income generation methods. With the basic knowledge requirements, you can interact easily with strategies to obtain passive income on your crypto assets. Here are the four important methods you can follow to earn passive income with DeFi.
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One of the foremost answers for “how to earn passive income with DeFi” would point you towards lending. It is the most commonly followed DeFi activity primarily because of the emphasis of early DeFi protocols on lending. For example, MakerDAO is one of the earliest entries in the DeFi ecosystem, which focused on lending protocols. Interestingly, the concept of loans in DeFi is quite simple, and you can find easy avenues for earning passive income.
You have to lend your digital or crypto assets to a platform by locking them in a smart contract. Subsequently, borrowers could access the deposited assets as loans by placing their own assets as collateral. The borrowers have to pay back the loan with interest to the platform. Then, the smart contracts distribute the interest among lenders according to the proportion of their assets locked in the platform.
The method of crypto lending is one of the trusted approaches for DeFi passive income generation for various reasons. First of all, the process of DeFi lending is quite clear and straightforward, which is also easy to use. You can just lock in your tokens in smart contracts for lending purposes. You could also unstake them when you want to take the tokens back. The next important detail of lending as an answer for “how to invest in DeFi” refers to higher interest rates.
In comparison to traditional accounts in banks which offer interest, DeFi lending can help you earn higher APYs. For example, you can learn more about a popular DeFi Lending Protocol, Compound, to discover some exciting details. The crypto lending platform offers an exceptional offer of more than 8.1% APY on your assets. The smart contracts serve as intermediaries or facilitators of the loans to borrowers alongside enforcing interest repayments from collateral deposits.
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Staking is also another common addition among responses for “how to earn passive income with DeFi.” It is the process in which users lock their tokens in a smart contract and are able to earn more of the same token. The token, in the case of staking, generally refers to the native token of the blockchain network. For example, ETH is the native token in the case of Ethereum network.
Various DeFi platforms leverage staking as an alternative for helping users in opening the equivalent of a savings account on the blockchain. Just like a savings account, your asset balance in the platform will help you accumulate additional income. The additional income is offered in the form of rewards by the network in the native tokens of the blockchain or other tokens on the same blockchain.
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Staking provides a credible avenue for passive income in DeFi and derives its origins from networks that use Proof-of-Stake algorithms. The Proof-of-Stake consensus algorithm basically implies that users on the platform would place their assets as stakes in the platform. In return for the trust shown by the users in the network, the platform rewards them with tokens.
Furthermore, the total contribution of users to the platform in form of stakes would also determine their governance privileges. Users with the highest stakes in a network would get the privilege of validating transactions on the network.
In the case of DeFi, staking is more than just a way to earn passive income with DeFi. As a matter of fact, it plays a crucial role in encouraging users to lock their assets in DeFi platforms for longer periods of time. Users who stake their assets in the platform would receive rewards from the net revenue.
Another interesting highlight about staking as a DeFi passive income generation method is that majority of DEXs featuring AMM systems allow users to stake the native tokens. Such facility is often termed as a “Savings” option and can help in earning a share of revenue generated by all solutions on the DeFi. For example, investors can earn fees from the swaps on liquidity pools. Investors could earn the rewards as additional tokens when they take their savings out of the stake.
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Take on the Identity of Liquidity Providers
The third proven approach for drawing promising levels of passive income with the help of DeFi is to provide liquidity. Many popular decentralized exchanges such as Yearn Finance and Uniswap have become successful with the adoption of Automated Market Maker or AMM protocols.
The DEXs do not depend on order books that were employed in traditional exchanges. On the contrary, the DEXs generate liquidity pools comprising of token pairs with equally distributed values. The equal value of token pairs has opened up the foundation for trading markets on DEXs while offering a plausible solution for “how to invest in DeFi” for favorable returns.
Liquidity pools are publicly accessible on a DeFi platform and allow anyone to provide liquidity in the pools. You can learn more about how liquidity pools lock in equal values of specific token pairs with the basics of liquidity pools in DeFi. For example, you could contribute liquidity in the amount of $3000 by offering $1500 worth of ETH and $1500 worth of USDT.
Now, you would be wondering about the ways to earn passive income in DeFi by providing liquidity. Upon locking in the assets in a liquidity pool, you would receive LP tokens or liquidity provider tokens. The LP tokens represent the share of an individual user in the total liquidity pool. Investors can redeem the LP tokens for recovering their stake alongside the revenue generated from swaps in the trading pair.
Liquidity providers can find a flexible answer for “how to earn passive income with DeFi” with the share of swap commission or fee. Based on the share of an investor in the liquidity pool, the platform determines the swap fee which should be awarded to them. APYs can be considerably higher for liquidity providers in DeFi platforms, albeit with a profound risk. Becoming a liquidity provider brings the additional risk of impermanent loss, and you need to be wary of it.
Impermanent loss is clearly evident due to the significant fluctuations in the price of pooled tokens. However, you can take necessary precautions for addressing the risk of impermanent loss in the DeFi passive income method of providing liquidity. Liquidity providers could address the concerns of impermanent loss through a selection of pools with high liquidity. On the other hand, liquidity providers can also choose pools with stablecoins or assets with less volatility.
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The most common answer for “how to invest in DeFi” would obviously bring attention to yield farming. The interesting aspect about yield farming is that it offers liquidity alongside providing a reliable instrument for passive income in DeFi. When you provide liquidity to a DeFi protocol by locking your assets in it, you get LP tokens.
You have the option of holding the LP tokens and redeeming them for recovering your original stake and other associated rewards. However, you could choose yield farming and discover an exceptional approach to earn passive income. You can lock the LP tokens in yield farms, which are basically DeFi protocols, and earn rewards in the same token or different tokens.
One could clearly notice the similarities of yield farming with staking and the practice of providing liquidity. However, yield farming is exclusive to LP tokens only. Therefore, if you want to earn passive income with DeFi through yield farming, you have to become a liquidity provider first. Another critical aspect of yield farming refers to the requirement of proper due diligence on the concerned DeFi platform.
Due diligence measures can help in identifying any form of discrepancies in the platform. In addition, you can also ensure safety from ‘rug pull’ scams wherein the developers can compromise LP tokens for withdrawing liquidity from the liquidity pools on DEXs. Therefore, it is reasonable to go with reputed platforms for yield farming that have a favorable reputation. In addition, you should also pay attention to external auditing of the smart contracts of the yield farming protocol.
Know the Key Differences between Staking Vs. Yield Farming Vs. Liquidity Mining
Ready to Earn More with DeFi?
As you can notice clearly, there are many potentially productive answers for “how to earn passive income with DeFi” when you search in the right direction. Before the arrival of DeFi, crypto assets were a mysterious enigma for financial investors and traders. However, the arrival of decentralized finance has changed the way we perceive the functionality and value of crypto assets. DeFi has opened up favorable prospects for accessing financial services on a decentralized infrastructure. At the same time, it has also prepped many paths for earning passive income with DeFi.
With so many promising methods such as yield farming, staking, becoming a liquidity provider, and crypto lending, you can earn passive income easily. The common thing in all the answers for “how to invest in DeFi” refers to locking your assets in a DeFi protocol. The type of returns on your assets depends on the method you have selected. For example, if you are providing liquidity to a platform, you get the rewards in form of LP tokens.
On the other hand, staking also gives the additional rewards of governance privileges in the protocol. In addition, the different traits of the methods for generating passive income through decentralized finance also present new possibilities. You can choose the one you want according to your flexibility and participation in DeFi. Learn more about investing in DeFi with the best practices suggested by experts right now!
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*Disclaimer: The article should not be taken as, and is not intended to provide any investment advice. Claims made in this article do not constitute investment advice and should not be taken as such. Do your own research!