Financial innovation has resulted in Decentralised Finance (DeFi) becoming a buzzword. DeFi is a blanket term used to define a variety of financial products and services that run on blockchains, and now encompasses everything from payment and transfer services to lending, borrowing, and trading. It is a combination of technologies and business models that tackle existing problems in the financial market.
To understand what Decentralised Finance is, we need to first understand what it isn’t. Unlike traditional finance that operates between savers and borrowers, DeFi seeks to eliminate third parties from the equation. The technology does this by enforcing a blockchain-based trust mechanism, thus allowing peer-to-peer (P2P) transactions without paying a fee to any third party such as a bank.
Here’s all you need to know to make passive income through DeFi.
“Staking” is the most ancient and fundamental method of earning cryptocurrency. It is the mechanism by which users can earn rewards by locking up their assets. In decentralised finance, staking can be used to earn rewards for lending or for operating a decentralised exchange. For instance, you could deposit some Ethereum (ETH) and after a few months, you’d get more ETH rewards for depositing and supporting the DeFi exchange.
But, why would you get more tokens? Well, there’s a rationale behind staking tokens. “Staking works on Proof-of-Stake (PoS) consensus mechanism that ensures that validators or ‘miners’ who are tasked to verify transactions do not game the system. If they do, they can be penalised by losing a part of their stake,” EasyFi Network, a decentralised finance platform wrote in a statement to indianexpress.com.
It should be noted that every transaction on the blockchain ecosystem has to be verified by ‘validators’. In return for verifying the transaction, they are rewarded with a ‘block’ that awards them tokens, for contributing to the network’s security and decentralisation.
Passive income can be earned in a variety of ways, one of which is lending and borrowing digital assets on DeFi platforms.
EasyFi Network, for instance, provides digital assets for borrowing and lending. But what makes this profitable? The platform notes that if you own an Ethereum, you may either lend it to a platform and earn a fixed return on it or trade ETH for a wrapped Ethereum (wETH) and use it as part of a DeFi protocol to earn an annual percentage yield (APY) of 0.5 per cent to 8 per cent. You may also borrow as much as 75 per cent of the value of your cryptos in return for collateralised loans. You may, in turn, trade or deposit these assets into a DeFi protocol to generate further passive income.
Produce your own tokens
Producing your own token is a way to make money in decentralised finance. Creating your own token and letting people use it as a way to earn a return on their assets is a great use case for decentralised finance. Some people have created tokens that have their own unique function, like serving as voting rights in an organisation. These people can make money by providing liquidity to other tokens. If a person is looking to trade tokens that they own but can’t get rid of easily, they can trade them for your token. If the token is accepted by other decentralised exchanges, those exchanges are likely to pay the token holder a small amount in the percentage of the profit they make.
At present, investing in DeFi is achieved through Yield farming, a method that works similarly to staking. However, unlike staking it is based on something called Liquidity Pools (LP).
By locking your assets, you earn something called LP tokens, which are required to invest in DeFi products. You have the option of either holding the LP tokens or swapping them for other cryptos and earning a cut. The final payout is determined by the monetary value of the tokens invested in the liquidity pool.
Smart contract development
Smart contract development allows you to create a customised use case for blockchain technology. If you develop a smart contract and deploy it to a decentralised network, you can earn money by charging developers for the use of your code.
“There are a few ways to make money with smart contract development. You could offer your code for free and earn a share of the profits that are coming from your code. Or you could charge a one-time fee for a specific instance of code. Staking is a way to make money with smart contract development. If you develop a smart contract that enables you to earn a share of the profits generated by other decentralised applications, you are staking,” the platform explained in a statement.
Every form of investment is subject to risks — and since blockchain is a nascent technology, it is accompanied by varying degrees of risk. In DeFi some of the major risks could be in the form of rug pull scams but again that could happen outside the DeFi space as well.
It is excessively important to check the reliability of any DeFi platform before investing in it since you might lose your profits if the market is bearish. DeFi earnings are directly proportional to the number of tokens received, and so you might lose as well if the market is volatile. There is no room for opportunists in DeFi, As decentralised finance grows, individuals will have a fair chance to participate in it, resulting in ample opportunities for wealth creation that have previously been restricted to the rich.