Obviously, one of the most attractive aspects of decentralized finance (DeFi) is the opportunity it gives for generating passive income and even administering payroll functions. No matter how you connect to DeFi apps, also known as dapps, whether it’s through decentralized Web3.0 gateways or through traditional web interfaces, many individuals and businesses are increasingly seeing the benefits of accessing alternative financial goods and services.
Because of the decentralized nature of DeFi, members can choose how they want to interact with one another, and the DeFi ecosystem is huge, with new components being added on a daily basis. Power users, such as businesses, are now leveraging smart-contract functionalities to automate the terms of their interactions and investments. For example, DeFi smart-contract tools are assisting businesses in getting the most out of insurance pooling and escrow, as well as other financial transactions. Synthetics gained appeal in early DeFi use cases as a result of the presence of decentralized synthetics hubs such as Shadows Network.
NFTs are likewise rising at a rapid pace, and their reach is now extending beyond collectibles. Even content delivery, which is the basic fiber of the internet, is now undergoing its own decentralized update, thanks to networks like as AIOZ and others.
However, the most intriguing feature for regular DeFi players is the ease with which they can generate profits simply by using their existing crypto assets. It is possible to earn profit from your assets by staking them into DeFi protocols, which is referred to as “yield” in the industry. This allows you to expand your cryptocurrency stack without putting it at risk through trading or other economic activities. When working with DeFi protocols, there are still hazards to consider; but, on the whole, it is a rather risk-free method of making income.
You can make a residual income through yield farming, staking, and lending, which will accrue in a steady stream over time. All it needs is a small amount of startup funding and a great deal of patience to get started. You will not get wealthy quickly, but your wealth will accrue over time. Furthermore, with a guaranteed income, you won’t have to worry about the market downturns that are unavoidable in the cryptocurrency world; even when prices are down, you’ll continue to earn.
As part of this article, we’ll look at four of the most common ways to generate passive income in DeFi, and we’ll look at some real-world instances of how these methods function. This article is written with the assumption that you have a basic understanding of how to connect with cryptocurrency networks and are comfortable with utilizing an Ethereum-based web wallet such as MetaMask. In addition, having some knowledge of prominent decentralized exchanges (DEXs) like as Uniswap is beneficial in this situation.
It is the procedure by which you lock (or “stake”) tokens into a smart contract in order to earn additional tokens of the same token in exchange for your initial investment. In most cases, the token in question is the native asset of the blockchain, such as ETH in the case of Ethereum, or a subset of it.
Why would anyone provide you free tokens in exchange for simply locking up your existing tokens in their system? To be sure, there is a rationale behind token incentives that goes beyond rewarding network users. Proof-of-Stake blockchains rely on users encrypting their assets and storing them in special smart contracts to ensure their security. In turn, network validators, who are entrusted with preserving the blockchain’s consensus rules and ensuring that no one attempts to scam the system, have ownership over these transactions. Validators who engage in unethical behavior may be penalized by having a portion of their stake forfeited.
Considering that cheating makes no economic sense, stakeholders are incentivized to lock up their assets for an extended period of time and receive rewards for making contributions to the network’s security and decentralization. Users that deposit their Ethereum into the Ethereum 2.0 smart contract will be rewarded with more Ethereum in exchange for their participation in upholding the consensus rules of the network. The fact that this process is automated eliminates the need for manual supervision. When you’ve deposited funds into the smart contract, you can sit back and let the Proof-of-Stake mechanism take care of the rest, while regularly claiming your payouts.
In the case of Ethereum 2.0, you are required to stake your funds for an extended amount of time, making this technique more suitable for users who like to spend their time in other ways. Despite the fact that the minimum amount required to stake in Ethereum 2.0 is 32 ETH, certain platforms use a pooling mechanism that allows you to deposit a less amount.
2. Become a liquidity provider
Swaps between token pairings, such as ETH and USDT, are supported via decentralized exchanges such as Uniswap and SushiSwap, among others. Defi users who wish to participate in the liquidity pool can do so by depositing their tokens into the smart-contract that controls the liquidity pool in question, which is controlled by liquidity providers (LPs). As a result, you will earn a 0.3 percent fee from all swaps on Uniswap’s DEX, which will be proportional to the percentage of your pool share. The greater the number of trades that are conducted through that pool, the greater the amount of money you will make.
Profitability is not usually guaranteed via LPing. When the price of one of the pooled tokens varies dramatically, you may experience temporary loss of money, which is referred to as transitory loss of money (IL). This can be mitigated by selecting highly liquid pools that include less volatile assets, such as WBTC/ETH, as opposed to volatile assets like Bitcoin.
In order to maximize your profits, you can use data from LP aggregators, who pull real-time data and assist you in projecting prospective returns from various pooling arrangements.
3. Yield farming
When you LP in a DEX such as Uniswap, you will receive tokens representing your pool share in exchange for your investment. To lock these tokens into yield farms, which are essentially DeFi protocols that reward you with more of the same token or with a different token, you must first complete the yield farm task. While your pooled assets are earning a portion of all fees in Uniswap, your LP tokens have the potential to earn a share of those fees as well!
Performing due diligence on the platform in issue is critical when yield farming to ensure that it is legitimate and that its developers have no intention of “rug pulling” by taking the site’s LP tokens and using them to withdraw liquidity from DEX pools. Selected established platforms with a good reputation and smart contracts that have undergone external verification are preferable.
Users receive an annual percentage yield (APY) from lending sites in exchange for encrypting their assets in a smart contract. These tokens are then used by borrowers, who in exchange for the tokens pay interest, a portion of which is returned to the lending institution. For example, Compound Finance is presently offering an annual percentage yield (APY) of 8.19 percent for lending DAI. A borrower’s failure to repay their debt is virtually impossible because the entire lending and borrowing process is managed by smart contracts. As a result, you should always be able to withdraw your staked assets at any time without any consequences.
Entrepreneurs staking, pooling, farming, and lending their assets through DeFi provide a mechanism for small enterprises to build their wealth while also contributing to the increase in liquidity and value of the entire ecosystem, according to the company. It’s never been easier to produce a consistent income, no matter which direction the market is trending.