Decentralized finance (DeFi) has opened up a whole new universe for customers who have been deprived of returns in conventional finance for decades. The potential for passive income from DeFi is enormous, and possibilities abound in this dynamic field of constantly expanding platforms, protocols, and exchanges.
- Deposit cryptocurrency in DeFi to get an APY.
The most straightforward approach to create a passive income with DeFi is to deposit your cryptocurrency on a platform or protocol that will give you an APY (annual percentage yield) for it.
Depositing on a DeFi network is possible with a wide range of currencies and tokens, but not with fiat cash (traditional currency). As a result, your initial step will be to purchase some bitcoin through a fiat on-ramp (i.e. buying crypto with cash). However, keep in mind that since the overwhelming bulk of DeFi works on the Ethereum blockchain, Bitcoin (BTC) is often not accepted.
- Select your token and protocol.
To earn an APY, most DeFi protocols will need you to deposit an Ethereum (ERC-20) token. Because you don’t have to worry about market volatility, this might be Ethereum’s native currency, Ether (ETH), or – more typically – a stablecoin like DAI or USDT. There is also an Ethereum version of Bitcoin, wBTC, whose price is linked to the most valuable cryptocurrency.
The proliferation of DeFi protocols over the past year has made it difficult to pick which to adopt. The ‘Earn Income’ option on DeFi Pulse enables users to search platforms by asset, thus it would be an excellent place to start. After choose which coin to deposit, you may purchase and sell it on a centralized or decentralized exchange.
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- The Fundamentals of Liquidity Mining
While receiving income on your assets is nice, it is far from the only thing you can do in DeFi. The next phase in the passive income path is to engage in liquidity mining, also known as yield farming. The first option is to stake or trade any incentives you get for depositing your crypto: often, the native token of the protocol or platform with which you invested.
These governance tokens often provide holders the ability to vote on protocol modifications, which has made many of them valuable on the secondary market.
- Borrowing and lending may help.
Another method for generating passive DeFi income is to borrow a token or coin from a platform and then reinvest it in the same or a different platform for rewards. If you own Bitcoin, for example, you might first exchange $1,000 in BTC for wBTC before depositing it into a DeFi protocol for a 0.5 percent APY. This is a little return, but by depositing that BTC, you may get a collateralized loan for another currency or token that offers a significant return, perhaps up to 75% of the value of your BTC ($750).
The loan may then be deposited (or lent) to you. By doing so, you have effectively unlocked an additional 75% of the value of your BTC to produce more passive income.Meanwhile, you continue to benefit from the original asset’s capital growth (which, in the case of BTC, has lately been rather strong), as well as interest and native/governance tokens, which you may stake on the platform or sell on a DEX to engage in further liquidity mining.
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Pitfalls of passive income
The above procedure may theoretically be repeated indefinitely, resulting in the famously complicated DeFi environment. Indeed, what we have shown above just scrapes the surface of what experienced users can achieve in DeFi, where leverage and derivatives may be leveraged to boost profits by up to 15 times.
Users that retain assets on several platforms face a number of concerns, including possible losses from smart contract vulnerabilities (also known as flash loan hacks) and excessive transaction costs (called ‘gas’) when the Ethereum network is crowded. The proliferation of DeFi protocols over the past year has made it difficult to pick which to adopt. Impermanent loss, which occurs when the price of your assets swings against you while they are deposited with a system, may also be a significant concern.
DeFi does not have to be challenging.
To summarize, in order to fully engage in generating a passive income via DeFi, a user must be highly experienced and often money wealthy in order to capitalize on large volume chances and be robust to losses. Furthermore, this is a far cry from DeFi’s initial ethos, which was envisioned as a platform where anybody could participate in depositing, borrowing, and lending for wealth creation, which has long been the domain of affluent elites in conventional banking.