- DeFi is a term for financial services available to the public on the blockchain using cryptocurrency, doing away with traditional services such as banks and brokerages.
- Users can access a range of services with fewer limitations, no paperwork, and no third party required.
- DeFi is available to anyone, and borrowing crypto is easy as long as you have crypto you can use as collateral.
- There are three main ways to earn passive income through DeFi: lending, staking, and yield farming.
- Lending is the easiest method, and stablecoins are the safest way to lend. Aave, Maker, and Compound are the top three DeFi lending platforms.
- Staking is the process of locking coins to verify transactions and support the functioning of the blockchain to earn a reward, which is paid out in the same coin that is staked.
More and more people are researching DeFi as an alternative to traditional finance, as the interest rates are much more attractive than any bank can offer. Although the gains are smaller in comparison to cryptocurrency (with its extreme volatility), a steady "safe" return of up to 20% per year with DeFi is definitely something that is worth considering. It is not a way to get rich quick, but rather a long-term investment strategy that can grow your investment substantially.
What is DeFi?
DeFi is an abbreviation of Decentralized Finance, and is a broad term for financial services available to all public users on the blockchain, using cryptocurrency, doing away with traditional services such as banks and brokerages.
With DeFi, users can access a range of services that banks traditionally offer, with fewer limitations, no paperwork, and no third party required. You can borrow and lend crypto, earn interest, buy insurance, and more; it is peer-to-peer and not constrained by geographical borders. DeFi is available to anyone, and borrowing crypto is easy as long as you have crypto you can use as collateral. There are no lengthy application processes or the need to show you can pay back a loan, like what is required in banks.
DeFi seems to be the way of the future, as people want more control over their money, and discover that there are ways they can earn high amounts of passive income.
Ways to earn passive income through DeFi
There are three main ways that you can use your cryptocurrency to earn you a passive income with DeFi. Each come with their own risks, so be sure to do your own research before jumping in due to FOMO.
The easiest method of earning passive income through DeFi is by lending your cryptocurrency. This is quite a simple concept even for crypto and DeFi beginners to grasp, because borrowing and lending are terms we understand from traditional finance.
In the traditional world, we don't find many opportunities where we can lend our money and receive interest payments. More often than not, we are borrowing money (to buy a car, or house, or with a credit card). DeFi allows users to lend their money easily to a platform, through the use of smart contracts. Other users on the platform borrow the cryptocurrency, and place their own digital assets as collateral. The interest that the borrowers pay to the platform is distributed to lenders by the smart contracts.
There is no limit on how long you must leave your crypto on the platform. If you are finished with lending, you can withdraw it at any time. You can lend many different cryptocurrencies, but the safest way is by lending stablecoins. This means that you are not affected if the crypto market crashes, since your coins are pegged to a fiat currency, (for example, USD). It is a great way to earn a stable passive income, and you can achieve rates of up to 9.5% APY on BlockFi. To check how much interest you can earn through lending platforms, click here, and you can compare rates. Alternatively, you can go with our top suggestions listed below.
Top 3 DeFi Lending Platforms
#1. Aave (Token: $AAVE)
The Aave Protocol is an Ethereum-based DeFi lending platform, and is #1 on our list of recommended places to earn passive income using DeFi. You can easily lend your cryptocurrency and earn interest immediately, that will compound in real-time. The yield (or interest) you will receive on your crypto changes continuously, and is determined by algorithms that detect the levels of supply and demand within the protocol.
Aave is ranked #1 because it is one of the most secure DeFi protocols, with frequent third-party audits and tests to ensure safety for their users. It was given a 95 Security Score by Certik.
#2. Maker (Token: $MKR)
MakerDAO is an Ethereum-based decentralized DeFi lending platform that is built upon their own stablecoin pegged to the USD, called Dai. MakerDAO is the longest-running and one of the most popular DeFi projects in the Ethereum ecosystem. They have around 2.3 million ETH locked in their protocol, which is more than 2% of the total supply of Ether.
#3. Compound (Token: $COMP)
Compound is another Ethereum-based algorithmic money market protocol, where their users can earn interest by lending their crypto assets. It is easy to contribute assets to Compound’s liquidity pool, and you will automatically earn interest on your crypto, which is constantly compounding, giving rise to the name of the protocol. The interest rate is continually being adjusted as the supply and demand dictates.
Compound is another very secure DeFi platform, holding a Security Score of 95.
Staking is another popular way to earn passive income using DeFi. Many cryptocurrency investors that have never ventured into DeFi will already be aware of what staking is, since it is offered on many of the popular cryptocurrency exchanges. For those that are unfamiliar with the term, staking is the name given to the process when crypto investors lock their coins in order to verify transactions and support the functioning of the blockchain. In return for their contribution, users receive a reward which is paid out in the same coin that they have staked. If you don't go into the technical aspect of it, staking is basically a way that you can earn interest on your crypto, like how you earn interest on your fiat currency in a bank account.
On many DeFi platforms, you can stake your cryptocurrency to build up the amount of coins you hold. However, it does more than just provide investors with passive income; it is an important way to encourage more users to lock their digital currency in DeFi platforms for longer.
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. Many decentralized exchanges feature automated market makers (AMM) and users can stake the native token. These are referred to as 'Savings' and help to earn a share of the revenue created on the DeFi platform, for example by receiving fees from liquidity pool swaps.
Yield farming is a term you may not have come across before researching DeFi. It can also be called liquidity mining, and it is a method of earning passive income on your crypto by locking it and receiving rewards in return. In this manner, it is similar to staking (described above), but the processes behind it are different.
It is more complicated compared to staking; most of the time it requires users (called liquidity providers, or LPs) to add funds to liquidity pools. A liquidity pool is a smart contract containing funds, and it is used to power a marketplace where other users can lend, borrow or exchange tokens. When LPs provide liquidity to the pool, by adding crypto funds to it, they receive a reward in return, typically paid from fees generated by the DeFi platform.
A lot of the time, the funds that are deposited by LPs are stablecoins that are pegged to the USD. This is a safe way for LPs to earn passive income, because no matter what happens to the crypto market, you are still receiving interest on your coins, which do not fluctuate in value.
However, there are risks you need to be aware of. First is the risk of dealing with smart contracts. Many protocols are built by small teams with limited budgets, which means the risk of bugs in the smart contract can be high. Even with bigger protocols which are audited by reputable firms, bugs are regularly found, and these could lead to you losing your deposited crypto assets. Be careful when you decide to lock your coins in a smart contract.
A bigger issue that you need to be aware of, is the fact that DeFi is composable, which means that DeFi applications can interact with each other seamlessly. The whole ecosystem of DeFi relies on each of the building blocks, and if one isn't working properly, everything else can be affected. This is one of the most important risks to be aware of, and you need to know that even if you trust the protocol you have researched, you need to also be careful about other protocols that are connected to it.
Top 3 Yield Farming Platforms
#1. Uniswap (Token: $UNI)
Uniswap comes first in our list of the best yield farming DeFi platforms. It is the second-largest decentralized exchange (DEX), only beaten by Curve Finance, which also makes our list. Uniswap has a total value locked of over $5.5 billion, which shows how popular they are. The interest rates vary based on the liquidity pool as well as market fluctuations, but you can expect to achieve around 20% to 50% APR.
#2. PancakeSwap (Token: $CAKE)
PancakeSwap is a decentralized exchange (DEX) like Uniswap, but the difference is it runs on the Binance Smart Chain (BSC) network, and not the Ethereum blockchain. It also has a focus on additional features, such as BSC token swaps, staking pools, a gambling game betting on the future price of BNB, and even NFT trading. You can achieve APR up to 250% when using PancakeSwap.
#3. Curve Finance (Token: $CRV)
Curve Finance is currently the largest decentralized exchange in the world, with a total value locked of $7.9 billion. Their platform uses a unique market-making algorithm which is beneficial to both users performing swaps and liquidity providers as well. Curve Finance has various pools for stablecoins (mostly pegged to USD) with respectable APRs. Liquid tokens are also available, with APR starting from around 1.9%. Expected APRs range from 2.5% up to over 30%.
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